Podcast Summary: Thoughts on the Market

Episode: Why a Fed Pivot Could Trigger Volatility
Host: Michael Zezas, Global Head of Fixed Income Research and Public Policy Strategy, Morgan Stanley
Date: September 3, 2025

Episode Overview

This episode features Michael Zezas discussing how a subtle shift in the Federal Reserve's reaction function—namely, an increased willingness to tolerate inflation in favor of managing downside growth risks—may impact markets through the end of 2025. Zezas analyzes the implications for various asset classes, explains why volatility is likely to rise despite a generally constructive outlook, and cautions listeners on the evolving policy landscape.

Key Discussion Points and Insights

1. Fed Policy Shift: Greater Tolerance for Inflation

• [00:15] The Fed, as underscored by Chair Jay Powell at Jackson Hole, is pivoting to focus more on downside growth risks, becoming "a bit more tolerant of inflation."
• This shift in reaction function means the Fed is less aggressively fighting inflation in the short term in favor of supporting growth.

2. Implications for the Timing and Pace of Rate Cuts

• [00:36] Colleagues Michael Gabin and Matthew Hornbach anticipate a rate cut as soon as September, starting a "quarterly pace of 25 basis point moves."
• Despite this earlier shift, the overall levels of policy rates forecasted by Morgan Stanley are only "slightly lower" than those implied by current futures markets.

3. Asset Class Impacts

a) US Government Bonds

• [01:04] “A slower economy and falling policy rates argue for lower treasury yields. But if investors grow more convinced that the Fed will tolerate firmer inflation, the curve could steepen further...” (Michael Zezas, 01:08)
• Risk: Long maturity yields may fall less—or even rise—if inflation expectations increase.

b) Corporate Bonds

• [01:24] A "slower but still expanding" economic growth outlook supports corporate debt markets, with lower front-end rates bolstering total return potential.
• Quote: “That, combined with lower front end rates, suggest a solid total return outlook for corporate credit...” (Michael Zezas, 01:32)
• However, rising long-term yields may limit the upside.

c) Equities/Stock Market

• [01:47] The outlook remains "constructive into year end," with "US earnings firm and recent tax cuts" benefiting corporate cash flows.
• Risk: If "long bonds sell off, this could put the rally at risk," particularly for growth stocks, as highlighted by colleague Mike Wilson.
• Quote: “Higher long end yields are a challenge to the valuation of growth stocks.” (Michael Zezas referencing Mike Wilson, 02:00)

4. Potential Policy Responses

• [02:16] Possible market interventions—like monetary policy pivots or adjustments to public policy (e.g., easing tariffs, changes to Treasury bond issuance)—would be reactive, not proactive.

5. Bottom Line Outlook

• [02:33] Zezas’s central view: "Many core markets set up to perform well, but the sailing should be less smooth than it has been in recent months."
• The primary takeaway is that volatility is set to increase as markets digest the Fed's new stance.

Notable Quotes & Memorable Moments

• On the Fed’s Policy Change:
  “The Fed looks more focused on managing downside growth risks and consequently a bit more tolerant of inflation.”
  — Michael Zezas [00:23]

• On the Path Ahead for Markets:
  “The Fed's increased tolerance for inflation is a new wrinkle. That means investors are likely to experience more volatility along the way.”
  — Michael Zezas [00:57]

• On Stock Market Risks:
  “If long bonds sell off, this could put the rally at risk, at least temporarily, as my colleague Mike Wilson has highlighted, given that higher long end yields are a challenge to the valuation of growth stocks.”
  — Michael Zezas [01:55]

Timestamps for Key Segments

• 00:00-00:36 – Overview and context of the Fed's policy shift
• 00:36-01:04 – Implications of timing and pace of anticipated Fed rate cuts
• 01:04-01:24 – Effects on US government bonds
• 01:24-01:47 – Effects on corporate bonds
• 01:47-02:16 – Effects on equities; risk to the year-end rally
• 02:16-02:33 – Discussion on possible policy responses
• 02:33-03:01 – Summary and outlook; closing remarks

Tone and Language

Michael Zezas delivers thoughtful, succinct analysis in a measured, analytical tone, characteristic of Morgan Stanley’s house style. The language is direct and informative, focusing on implications over speculation, with an emphasis on risk management and a prudent approach for investors.

For investors: The episode cautions that while overall market performance may remain positive, volatility is expected to increase as the Fed subtly pivots and markets reassess inflation tolerance.