Podcast Contributor: Andrew Sheets

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Lisa Shalett: And I'm Lisa Shalett, Chief Investment Officer for Morgan Stanley Wealth Management.

Andrew Sheets: Today, is inflation really transitory or are we entering a new era where higher prices are the norm?

Andrew Sheets: It's Thursday, December 18th at 4pm in London.

Lisa Shalett: And it's 11am in New York.

Andrew Sheets: Lisa, it's great to talk to you again. And, you know, we're having this conversation in the aftermath of, kind of, an unusual dynamic in markets when it comes to inflation. Because inflation is still hovering around 3 percent. That's well above the Federal Reserve’s 2 percent target. And yet the Federal Reserve recently lowered interest rates again. Fiscal policy remains very stimulative, and I think there's this real question around whether inflation will moderate? Or whether we're going to see inflation be higher for longer. And you know, you are out with a new report touching on some of the issues behind this and why this might be a structural shift higher in inflation.

So, we'd love to get your thoughts on that, and we'll drill down into the various drivers as this conversation goes on.

Lisa Shalett: Thanks Andrew. And look, I think as we take a step back, and the reason we're calling this a regime change is because we see factors for inflation coming from both the demand side and the supply side. For example, on the demand side, the role of the infrastructure boom, the GenAI infrastructure boom, has become global. It has caused material appreciation of many commodities in 2025. We're seeing it obviously in some of the dynamics around precious metals. But we're also seeing it in industrial metals. Things like copper, things like nickel.

We're also seeing demand factors that may stem from the K-shaped economy. And the K-shaped economy, as we know, is really about this idea that the wealthiest folks are increasingly dominating consumption. And they are getting wealthy through financial asset inflation.

On the supply side, there are dynamics like immigration, dynamics around the housing market that we can talk about. But perhaps the wrapper around all of it is how policy is shifting – because increasingly policymakers are being constrained by very high levels of debt and deficits. And determining how to fund those debts and deficits actually removes some of the degrees of freedom that central bankers may have when it comes to actually using interest rates to constrain demand.

Andrew Sheets: Well, Lisa, this is such a great point because we're financial analysts. We're not political analysts. But it seems safe to say that voters really don't like inflation. But they also don't like some of the policies that would traditionally be assigned to fight inflation – be they higher interest rates or tighter fiscal policy.

And even some of the more recent political shifts that we've seen – I’m talking about the U.S. around, say, immigration policy could arguably be further tightening of that supply side of the economy – measures designed to raise wages, almost explicitly in their policy goals. So how do you see that dynamic? And, again, kind of where does that leave, you think, policy going forward?

Lisa Shalett: Yeah. I think the very short answer – our best guess is that policy becomes constrained. So, on the monetary side, we're already seeing the Fed beginning to signal that perhaps they're going to rely on other tools in the toolkit. And what are those tools in the toolkit? Well, they're managing the size of their balance sheet, managing the duration or the mix of things that they hold in the balance sheet. And it's actual, you know, returns to how they think about reserve management in the banking system. All of those things, all of those constraints may enable the U.S. government to fund debts, right? By buying the Treasury bill issuance, which is, you know, swollen to almost [$]2 trillion a year in terms of U.S. deficits.

But on the fiscal side, right, the interest payments on debt, begins to crowd out other government spending. So, policy itself in this era of fiscal dominance becomes constrained – both in, you know, Washington, D.C. and from Congress – what they can do, their degrees of freedom – and what the central bank can do to actually control inflation.

Andrew Sheets: Another area that you touch on in your report is energy and technology, which are obviously related with this large boom that we're seeing – and continue to expect in AI data center construction. This is a lot of spending on the technology. This is a lot of power needed to power that technology and U.S. data center electricity demand is growing at a rapid rate. And transmission constraints are causing prices to go up. A price that is a pretty visible price for a lot of people when they get their utility bill. So, how do these factors you think shape the story? And where do you think they're going to go as we look into the future?

Lisa Shalett: Yeah, 100 percent. I mean, I think, you know, when we talk about, you know, who's going to dominate in Generative AI globally, one of the factors that we have to take into consideration is what is the cost of power? What is the cost of electricity? What is the age of the infrastructure to both generate that electricity and transport it? And transmit it?

This is one of the areas where the U.S., at the minute, is facing genuine constraints. When you think about some of the forecasts that have been put out there in terms of $10 trillion of spending related to Generative AI, the number of data centers that are going to be built, and the power shortfall that has been forecast. We're talking about someone having to pay the price, if you will, to ration power until you can upgrade the grid.

And in the U.S., that grid upgrade, to be blunt, has lagged some of the rest of the world. Not only because the rest of the world was slower to modernize and leapfrogged in many ways. But we know in China, for example, they have one of the lowest electricity generation costs on the planet. That is an advantage for them. So, we have to consider that power generation writ large is potentially a force for upward inflation, at least in the short term.

Andrew Sheets: So we have the fiscal policy backdrop. We have an AI spending backdrop both contributing to the demand side of inflation. We have these supply constraints, whether it's housing or labor also, you know, potentially being more structural drivers of higher inflation.

The question I'm sure that investors are asking you is, what should they do about it? So, can you walk us through the key strategies that investors might want to consider as they navigate a new inflationary regime?

Lisa Shalett: Sure. So, the first thing that we think it's really important for folks to appreciate is that typically when we've been in these higher inflation regimes in the past, stocks and bonds become positively correlated. And what that means is that the power of a very simple 60-40 or stock-bond-cash portfolio to provide complete or optimal diversification fades. And it requires investors to potentially consider investing, especially beyond fixed income. 

Stocks very often are pro-inflationary assets; meaning many, many companies have the power to pass through price increases. If you are consuming income from a fixed income or a bond instrument, inflation is your enemy, right? Because it's eating into your real returns. And so, one of the things that we're talking with our clients a lot about in terms of portfolio construction are things like adding real assets, adding infrastructure assets, adding energy, transportation assets, adding commodities. Adding gold even, to a certain extent. 

Andrew Sheets: Just to play devil's advocate, you can imagine that some investors might say, ‘Well, I can look in the market at long-term inflation expectations.’ And those long-term inflation expectations have been kind of stable and a bit above the Fed's target. But not dramatically. So, what do you say to that? And what do you think those markets either might be missing? Or how could investors leverage that more benign view that's out there in the market?

Lisa Shalett: Yeah, so look, I think here's where the debate, right? Our perception has been that inflation expectations have remained extraordinarily anchored – because investors have actually reasonably short memories on the one hand, and we have, by and large, been in disinflationary times. Second, there's extraordinary faith in policy makers – that policy makers will fight inflation. And I think the third thing is that there's extraordinary faith in the deflationary forces of technology.

Now, all three of those things may absolutely, positively be true. The problem that we have is that the alternate case, right? The case that we’re making – that maybe we’re in a new inflationary regime is not priced, and the risk is non-zero.

And so, what we see, and what we’re watching is – how steep does the yield curve get, right? As we look at yields in the 10-30-year tenure – what is driving those rates higher? Is it a generic term premium? Or are we starting to see an unanchoring, if you will, of inflation expectations. And it takes a while for people to appreciate regime change.

And so, look, as is always the case, there’s no absolutes in the market. There’s no one theory that is priced and the other theory is not. But sometimes you want to hedge, and we think that we're going through a period where diversified portfolios and hedging for these alternative outcomes -- because there are such powerful structural crosscurrents – is the preferred path.

Andrew Sheets:  Lisa, thanks for sharing your insights

Lisa Shalett: Of course, Andrew. That's my pleasure.

Andrew Sheets:  As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us, wherever you listen. It helps more people find the show.

Andrew Sheets: Welcome to Thoughts in the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today I'm going to talk about our outlook for global credit markets in 2026 and why we think the credit cycle burns hotter before it burns out.

It's Friday, December 12th at 2pm in London.

Surely it can't go on like this. That phrase is probably coming up a lot as global credit investors sit down and plan for 2026. Credit spreads are sitting at 25 year plus tights in the U.S. and Asia. Issuance in corporate activity are increasingly aggressive. Corporate CapEx is surging. Signs of pressure are clear in the lowest rated parts of the market. And credit investors are trained to worry. Aren't all of these and more signs that a credit cycle is starting to crack under its own weight?

Not quite yet, according to our views here at Morgan Stanley. Instead, we think that 2026 brings a credit cycle that burns hotter before it burns out. The reason is partly due to an unusually stimulative backdrop. Central banks are cutting interest rates. Governments are spending more money, and regulatory policy is easing. All of that, alongside maybe the largest investment cycle in a generation around artificial intelligence, should spur more risk taking from a corporate sector that has the capacity to do so.

In turn, we think the playbook for credit is going to look a lot like 2005 or 1997-1998. Both periods saw levels of capital expenditure, merger activity, interest rates, and an unemployment rate that are pretty similar to what Morgan Stanley expects next year. And so, looking ahead to 2026, these two periods offer two competing ways to view the year ahead.

2025 might be more similar to a period where the low-end consumer really is starting to struggle, but that another force – back then it was China, now it might be AI spending – keeps the broader market humming. 1997 or 1998, on the other hand, would be more similar to a narrative that investors are growing more confident that a new technology is really transformative. Back then, it was the internet and now it's AI.

Corporate bond issuance we think will be central to how this resolves itself. This is a strong regional theme and a key driver of our views across U.S., European and Asia Credit. We forecast net issuance to rise significantly in U.S. investment grade up over 60 percent versus 2025 to a total of around $1 trillion.

That rise is powered by a continued increase in technology spending to fund AI as well as a broader increase in capital expenditure and merger activity. All of those bonds being sold to the market should mean that U.S. spreads need to move wider to adjust. And that's true, even if underlying demand for credit remains pretty healthy, thanks to high yields, and the economy ultimately holds up.

We think this story is a bit better in other areas and regions that have less relative issuance, including European and Asian investment grade and global high yield. They all outperform U.S. investment grade on our forecast. In total returns, we think that all of these markets produce a return of around 4 to 6 percent, and if that's true, it would underperform, say U.S. equities, but outperform cash.

More granularly similar to 2025 or 2005, we think that single name and sector dispersion remain major themes. And where you position in maturity should also matter. Credit curves are steep and our U.S. interest rate strategist are expecting the U.S. Treasury curve to steepen significantly Further. That should mean that so-called carry and roll down and where you position on the maturity curve are a pretty big driver of your ultimate result. In our view, corporate bonds between five- and 10-year maturity in both the U.S. and Europe will offer the best risk reward.

The most significant risk for global credit remains recession, which we think would argue for wider spreads on both economic rounds, but also through weaker demand as yields would fall. It would mean that our spread forecasts are too optimistic and that our expectation that high yield outperforms investment grade would be wrong. And then there's a milder version of this bear case – that aggression and corporate supply are even stronger than we think, and that creates conditions closer to late 1998 or 1999.

Back then, U.S. investment grade spreads were roughly 30 basis points wider than current levels, even though the economy was strong and even though the equity market kept going up.

Thank you as always for your time. If you find Thoughts of the Market useful, let us know by leaving a review wherever you listen. And also, please tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today, a look at a very different type of challenge for credit markets.

It's Friday, November 21st at 6pm in Singapore.

It has now been well over 15 years since the Global Financial Crisis shook the credit markets to its very core. It's hard to state just how extreme that period was. How many usual relationships and valuation approaches broke. It saw the worst credit losses in 80 years; I think, and hope, that this record will hold for the next 80.

This shock, however, did have a silver lining for the credit market. After a crisis that was driven by bank balance sheets being too large and complex, they shrank and simplified. After companies saw capital markets suddenly shut, they increased their cash levels and often managed themselves more conservatively.

The housing market long, the engine of debt growth in the U.S. saw much tighter lending standards and less overall borrowing. And so, all these trends had a common theme. Less bond supply. The credit market has seen numerous bouts of volatility in the years since. But these have generally been driven by concerns around the macro economy, like the eurozone crisis or COVID. Or they've been driven by companies’ specific issues such as weakness around the oil sector in the mid 2010s or the collapse of Silicon Valley Bank in 2023. The idea that there would be too much borrowing for the level of demand and that this causes market weakness, well, it just hasn't been an issue.

Until – that is – now.

As we've discussed on this program, there is an enormous increase underway in the amount of capital expenditure by technology companies as they look to build out the infrastructure that supports their cloud and AI ambitions. Morgan Stanley Equity Research estimates that the largest spenders will commit about $470 billion of spending this year and [$]620 billion of spending next year. That's over $1 trillion of spending in just a two-year period. And it's still growing. We see a lot of momentum behind this spending, as the companies doing it have both enormous financial resources and see it as central to their future ambitions.

But all this spending, however, will need to come from somewhere. These are often very profitable companies and so we think about half will be funded from their cash flows. The other half, well, debt markets will play a big role, especially as these companies are often highly rated and so have significant capacity to borrow more. And over the last few weeks, those spigots have now turned on. Several large technology hyperscalers have been borrowing tens of billions at a clip, and they've been doing this in short succession.

There is some good news here. This new borrowing has been coming at a discount, with the issuers willing to pay investors a bit more than their existing debt to take it on. Demand in turn has been very high for this debt. And in most cases, this borrowing is still well below anything that could feasibly trigger rating agency action.

But it is raising a very different type of issue after a long period where, generally speaking, investors have rarely worried about excessive supply – these are very large deals coming at very large discounts, and they are moving the market. If a AA rated company is in the market willing to pay the same as a current single A, well, that existing single A credit just simply looks less attractive.

As far as problems go, we think this is a generally less scary one for the market to face but is a new challenge – something we haven't encountered for some time. And based on the aforementioned spending plans, it may be with us for some time to come.

Thank you as always, for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today – a discussion of merger and acquisition activity or M&A. Last year, we had a view that this activity would pick up significantly. We think we're seeing that increase now. It has further to go.

It's Wednesday, October 29th at 2pm in London.

We have been firm believers at Morgan Stanley in a significant multi-year uplift in global merger and acquisition activity or M&A. That conviction remains. The incentives for this type of action are strong in our view; activity still lags what fundamentals would suggest, and supportive regulatory shifts are real.

M&A has now returned, and importantly, we think there's much further to go. Indeed, M&A is very closely linked to corporate confidence, and we think investors need to consider the possibility that we'll see an even bigger surge in this confidence – or a boom.

First, policy uncertainty is declining as U.S. tax legislation has now passed, and tariff rates get finalized. It's the relative direction of this uncertainty that we think matters most for corporate confidence.

Second, interest rates are declining with the Fed, European Central Bank, and Bank of England all set to cut rates further over the next 12 months. Third, bank capital requirements may decline in the view of Morgan Stanley analysts, which would unlock more lending for these types of transactions.

Fourth, and very importantly, the regulatory backdrop is becoming more accommodative in both the U.S. and in Europe. Indeed, we think that companies may think that this is going to be the most permissive regulatory window for transactions that they might get for some time. Fifth, private equity, which is a big driver of M&A activity, is sitting on over $4 trillion of dry powder in our view – at a time when credit markets look very wide open for financing their transactions.

And finally, we're seeing a surge in capital expenditure on Morgan Stanley estimates, which we see as a sign of rising corporate confidence, and importantly an urgency to act – with corporates far less content to simply sit back and repurchase their stock.

All of these favorable conditions together argue for activity to push even higher. We forecast global M&A volumes to increase by 32 percent this year, an additional 20 percent next year, and reach $7.8 trillion in volume in 2027.

This is a global story with M&A rising across regions, especially in Japan. It has cross-asset implications with M&A already being one of the biggest drivers of bond outperformance within the U.S. high-yield market. And this is also a story where we see a lot of value in bringing together macro and micro perspectives.

While we think the top-down conditions look favorable for all the reasons I just mentioned, we also see a very encouraging picture bottom up. We polled a large number of Morgan Stanley sector analyst teams and asked them about M&A conditions in their sector. A large majority of them see more activity.

So, where could these more specific implications lie? Well, as you heard on yesterday's episode, Healthcare and Biotech may see an uptick in activity. In the U.S., we also think that Banking and Media stand out. In Europe, Business Services, Metals and Mining, and Telecom seem most ripe for more M&A.

Aerospace and Defense is an interesting sector that may see more M&A within multiple regions, including the U.S. and Europe, as companies look for scale. And with smaller companies trading at a valuation discount to their larger peers across the world, Morgan Stanley analysts generally see the strongest case for activity in larger companies acquiring these smaller ones.

Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley. 

Today – the debate about whether elevated capital expenditure and AI technology is showing classic warning signs of overbuilding and worries for credit.  

It's Thursday, October 23rd at 2pm in London. 

Two things are true. AI related investment will be one of the largest investment cycles of this generation. And there is a long history of major investment cycles causing major headaches to the credit market. From the railroads to electrification, to the internet to shale oil, there are a number of instances where heavy investment created credit weakness, even when the underlying technology was highly successful.  

So, let's dig into this and why we think this AI CapEx cycle actually has much further to run. 

First, Morgan Stanley has done a lot of good collaborative in-depth work on where the AI related spend is coming from and what's still in the pipeline. And importantly, most of the spending that we expect is still well ahead of us. It's only really ramping up starting now.  

Next, we think that AI is seen as the most important technology of the next decade by some of the biggest, most profitable companies on the planet. We think this increases their willingness to invest and stick with those investments, even if there's a lot of uncertainty around what the return on all of this expenditure will ultimately be.  

Third, unlike some other major recent capital expenditure cycles – be they the internet of the late 1990s or shale oil of the mid 2010s, both of which were challenging for credit – much of the spending that we're seeing today on AI is backed by companies with extremely strong balance sheets and significant additional debt capacity. That just wasn't the case with some of those other prior investment cycles and should help this one run for longer.  

And finally, if we think about really what went wrong with some of these prior capital expenditure cycles, it's often really about overcapacity. A new technology – be it the railroads or electricity or the internet – comes along and it is transformational. 

And because it's transformational, you build a lot of it. And then sometimes you build too much; you build ahead of the underlying demand. And that can lower returns on that investment and cause losses. 

We can understand why large levels of AI capital investment and the history of large investment cycles in the past causes understandable concern. But when tying these dynamics together, it's important to remember why large investment cycles have a checkered history. It's usually not about the technology not working per se, but rather a promising technology being built ahead of demand for it and resulting in excess capacity driving down returns in that investment, and the builders lacking the financial resources to bridge that gap. 

So far, that's not what we see. Data centers are still seeing strong underlying demand and are often backed by companies with exceptionally good resources. We need to watch if either of these change.  

But for now, we think the AI CapEx cycle has much further to go.  

Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley

Vishy Tirupattur: And I'm Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist.

Andrew Sheets: Today, as we're hosting the Morgan Stanley European Leveraged Finance Conference, a discussion of three of the biggest topics on the minds of credit investors worldwide.

It's Thursday, October 16th at 4pm in London.

Vishy, it's so great to catch up with you here in London. I know you've been running around the world, quite literally, talking to investors about some of the biggest debates in credit – and that's exactly what we wanted to talk. We're here at Morgan Stanley's European Leveraged Finance Conference. We're talking with investors about the biggest debates, the biggest developments in credit markets, and there are really kind of three topics that stand out.

There's what's going on with private credit? What's going on with the merger and acquisition, the M&A cycle? And how are we going to fund all of this AI infrastructure?

And so maybe I'll throw the first question to you. We hear a lot about private credit, and so maybe just for the listener who's looking at a lot of different things. First, how do you define it? What are we really talking about when we're talking about private credit?

Vishy Tirupattur: So, Andrew, when we talk about private credit, the most common understanding of private credit is lending by non-banks to small and medium sized companies. And we probably will discuss a bit later that this definition is actually expanding much beyond this narrow definition. So, when you think about private credit and spend time understanding what is the credit in private credit, what it boils down to is on average, on a leveraged basis, the credit in private credit is comparable to, say CCC to B - on a coverage basis to the public markets.

So, the credits in the private credit market are weaker. But on the other hand, the quality of covenants in these deals is significantly better compared to the public credit markets. So, that's the credit in private credit.

Andrew Sheets: So, Vishy, with that in mind then, what is the concern in this market? Or conversely, where do people see the opportunity?

Vishy Tirupattur: So, the concern in this market comes from the opaqueness in these deals. Many of these private credit borrowers are not public filers. So not much is well known about what the underlying details are. But in a sense, a good part of the public markets, whether it's in high yield bonds or in the public, broadly syndicated leveraged loans are also not public filers. So, there is information asymmetry in those markets as well.

So, the issue is not the opaqueness of private markets, but opaqueness in credit in general. But that said, when you look at the metrics of leverage, coverage, cash on balance sheet…

Andrew Sheets: Because we can get some kind of high-level sense of what is in these portfolios...

Vishy Tirupattur: Yeah. And we look at all those metrics, and we look at a wide range of metrics. We don't get to the conclusion that we are at a precipice of some systemic risk exposure in credit. On the other hand, there are idiosyncratic issues. And these idiosyncratic issues have always been there and will remain there. And we would expect that the default rates are sticky around these levels, which are slightly above the long-term average levels, and we expect that to remain.

Andrew Sheets: So, you may see more dispersion within these portfolios. These are weaker, more cyclical, more levered companies. But overall, this is not something that we think at the moment is going to interrupt the credit cycle or the broader markets dynamic.

Vishy Tirupattur: Absolutely. That is exactly where we come down to.

So, Andrew, let me throw another question back at you. There's a lot of talk of growing M&A, growing LBO activity. And that could potentially lead to some challenges on the credit front. How do you look at it?

Andrew Sheets: So, I'd like to actually build upon your answer from private credit, right? Because I think a lot of the questions that we're getting from investors are around this question of how far along in this always, kind of, cyclical process; ebb and flow of lending aggressiveness are we? And, you know, this is a cycle that goes back a hundred years – of lenders becoming more conservative and tighter with lending. And then as times get good, they become somewhat looser. And initially that's fine. And then eventually something, something happens.

And so, I think we've seen the development of new markets like private credit that have opened up new lending opportunities and then also new questions. And I think we've also seen this question come up around M&A and corporate activity.

And as we start to see headlines of very large leveraged buyouts or LBOs, as we start to see more merger and acquisition – M&A – activity coming back; something we've at Morgan Stanley been believers in. Are we really starting to see the things that we saw in the year 2000, or in the year 2007, when you saw very active capital markets actually coinciding with kind of near the peak of equity markets near the top of major market cycles.

And in short, we do not think we're there yet. If we look at the actual volumes that we're seeing, we're actually a little bit below average in terms of corporate activity. There's really been a dearth of corporate activity after COVID. We're still catching up. Secondly, the big transactions that we're seeing are still more conservatively structured, which isn't usually what you see right at the end. And so, I think between these two things with still a lot of supportive factors for more corporate activity, we think we have further to go.

Vishy Tirupattur: On that point, Andrew, I think if you look at the LBOs that are happening today versus the LBOs that happened in the 2007 era, the equity contribution is dramatically different. You know, equity to debt, these LBOs that are happening today [are] of a substantially higher amount of equity contribution compared to the LBOs we saw pre-Financial Crisis…

Andrew Sheets: That's such a great point. And the listener may not know this, but Vishy and I were working together at Morgan Stanley prior to the Financial Crisis, and we were working in credit research when a lot of these LBOs were happening, and…

Vishy Tirupattur: And I used to be tall and good looking.

Andrew Sheets: (laughs) And they were just very different. We're still not there. If you go back and pull the numbers, you're looking at transactions still that are far more conservative than what we saw then. So, you know, this activity is cyclical, and I think we do have to watch deregulation, right? You saw a lot of regulations come in after the Financial Crisis that led to more conservative lending. If those regulations get rolled back, we could really move back towards more aggressive lending. But we haven't quite seen that yet.

Vishy Tirupattur: Absolutely not.

Andrew Sheets: And Vishy, maybe the third question that comes up a lot. We've covered private credit, which is very topical. We've covered kind of corporate aggressiveness. But maybe the icing on the cake. The biggest question is AI – and is AI spending?

And it just feels like every day you come into the office and there's another headline on CNBC or Bloomberg about another mega AI funding deal. And the question is, okay, where's all that money going to come from?

And maybe some of it comes from these companies themselves. They’re very profitable, but credit might have to fill in some of the gaps. And you and some of our colleagues have done a lot of work on this. Where do you think kind of the lending story and the borrowing story fits into this broader AI theme?

Vishy Tirupattur: Our estimate of simply data center related CapEx requirements are close to $3 trillion. You add the power required for the data centers and add another $300-400 billion. So, a lot of this CapEx will come from – roughly about half might come from the operating cash flows of the hyperscalers. But the rest, so [$]1.5 trillion plus, has to come through various channels of credit.

So, unsecured corporate credit, we think will play a fairly small role in this. Of that [$]1.5 trillion plus, maybe [$]200 billion to come from unsecured credit issuance by these hyperscalers, and perhaps some of the securitized markets, such as ABS and CMBS that rely on stabilized cash flows may be another 1[$]50 billion. But a different version of private credit, what we will call ABF or asset based finance, will play a very big role. So north of [$]800 billion we think will come from that kind of a private credit version of investment grade, or a private credit markets developing. So, this market is very much in the developmental mode.

So, one way or the other, for AI to go from where it is today to substantially improving productivity and the earnings of companies that has to go through CapEx; and that CapEx needs to go through credit markets.

Andrew Sheets: And I think that is so fascinating because, right Vishy, so much of the spending is still ahead of us. It hasn't even really started, if you look at the numbers.

Vishy Tirupattur: Absolutely. We are in the early stages of this CapEx cycle. We should expect to see a lot more CapEx and that CapEx train has to run through credit markets.

Andrew Sheets: So, Vishy, there's obviously a lot of history in financial markets of larger CapEx booms, and some of them work out well, and some of them don't. I mean, if you are trying to think about some of the dynamics of this funding for AI and data centers more broadly versus some of these other CapEx cycles that investors might be familiar with. Are there some similar dynamics and some key differences that you try to keep in mind?

Vishy Tirupattur: So, in terms of similarities, you know, they're big numbers, whichever way you cut it, these numbers are going to be big dollar numbers.

But there are substantial differences between the most recent CapEx boom that we saw towards the end of the late 90s, early 2000s; we saw a massive telecom boom, telecom related CapEx. The big difference is that spending was done by – predominantly by companies that had put debt on their balance sheet. They were already very leveraged. They were just barely investment grade or some below investment grade companies with not much cash on their balance sheet.

And you contrast that with today's world, much of this is being done by highly rated companies; the hyperscalers or between, you know, A+ to AAA rated companies, with a lot of cash on their balance sheets and with very little outstanding debt on their part.

On top of that, the kind of channels that exist today, you know, data center, ABS and CMBS, asset-based finance, joint venture kind of financing. All of these channels were simply not available back then. And the fact that they all are available today means that this risk of CapEx is actually much more widely distributed.

So that makes me feel a lot better about the evolution of this CapEx cycle compared to the most recent one we saw.

Andrew Sheets: Private credit, a rise in M&A and a very active funding market for AI. Three big topics that are defining the credit debate today. Vishy, thanks for taking the time to talk.

Vishy Tirupattur: Andrew, always fun to hang with you.

Andrew Sheets: And thank you for listening. If you enjoy Thoughts on the Market, please leave us review wherever you listen and tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley

Vishy Tirupattur: And I'm Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist.

Andrew Sheets: Today, as we're hosting the Morgan Stanley European Leveraged Finance Conference, a discussion of three of the biggest topics on the minds of credit investors worldwide.

It's Thursday, October 16th at 4pm in London.

Vishy, it's so great to catch up with you here in London. I know you've been running around the world, quite literally, talking to investors about some of the biggest debates in credit – and that's exactly what we wanted to talk. We're here at Morgan Stanley's European Leveraged Finance Conference. We're talking with investors about the biggest debates, the biggest developments in credit markets, and there are really kind of three topics that stand out.

There's what's going on with private credit? What's going on with the merger and acquisition, the M&A cycle? And how are we going to fund all of this AI infrastructure?

And so maybe I'll throw the first question to you. We hear a lot about private credit, and so maybe just for the listener who's looking at a lot of different things. First, how do you define it? What are we really talking about when we're talking about private credit?

Vishy Tirupattur: So, Andrew, when we talk about private credit, the most common understanding of private credit is lending by non-banks to small and medium sized companies. And we probably will discuss a bit later that this definition is actually expanding much beyond this narrow definition. So, when you think about private credit and spend time understanding what is the credit in private credit, what it boils down to is on average, on a leveraged basis, the credit in private credit is comparable to, say CCC to B - on a coverage basis to the public markets.

So, the credits in the private credit market are weaker. But on the other hand, the quality of covenants in these deals is significantly better compared to the public credit markets. So, that's the credit in private credit.

Andrew Sheets: So, Vishy, with that in mind then, what is the concern in this market? Or conversely, where do people see the opportunity?

Vishy Tirupattur: So, the concern in this market comes from the opaqueness in these deals. Many of these private credit borrowers are not public filers. So not much is well known about what the underlying details are. But in a sense, a good part of the public markets, whether it's in high yield bonds or in the public, broadly syndicated leveraged loans are also not public filers. So, there is information asymmetry in those markets as well.

So, the issue is not the opaqueness of private markets, but opaqueness in credit in general. But that said, when you look at the metrics of leverage, coverage, cash on balance sheet…

Andrew Sheets: Because we can get some kind of high-level sense of what is in these portfolios...

Vishy Tirupattur: Yeah. And we look at all those metrics, and we look at a wide range of metrics. We don't get to the conclusion that we are at a precipice of some systemic risk exposure in credit. On the other hand, there are idiosyncratic issues. And these idiosyncratic issues have always been there and will remain there. And we would expect that the default rates are sticky around these levels, which are slightly above the long-term average levels, and we expect that to remain.

Andrew Sheets: So, you may see more dispersion within these portfolios. These are weaker, more cyclical, more levered companies. But overall, this is not something that we think at the moment is going to interrupt the credit cycle or the broader markets dynamic.

Vishy Tirupattur: Absolutely. That is exactly where we come down to.

So, Andrew, let me throw another question back at you. There's a lot of talk of growing M&A, growing LBO activity. And that could potentially lead to some challenges on the credit front. How do you look at it?

Andrew Sheets: So, I'd like to actually build upon your answer from private credit, right? Because I think a lot of the questions that we're getting from investors are around this question of how far along in this always, kind of, cyclical process; ebb and flow of lending aggressiveness are we? And, you know, this is a cycle that goes back a hundred years – of lenders becoming more conservative and tighter with lending. And then as times get good, they become somewhat looser. And initially that's fine. And then eventually something, something happens.

And so, I think we've seen the development of new markets like private credit that have opened up new lending opportunities and then also new questions. And I think we've also seen this question come up around M&A and corporate activity.

And as we start to see headlines of very large leveraged buyouts or LBOs, as we start to see more merger and acquisition – M&A – activity coming back; something we've at Morgan Stanley been believers in. Are we really starting to see the things that we saw in the year 2000, or in the year 2007, when you saw very active capital markets actually coinciding with kind of near the peak of equity markets near the top of major market cycles.

And in short, we do not think we're there yet. If we look at the actual volumes that we're seeing, we're actually a little bit below average in terms of corporate activity. There's really been a dearth of corporate activity after COVID. We're still catching up. Secondly, the big transactions that we're seeing are still more conservatively structured, which isn't usually what you see right at the end. And so, I think between these two things with still a lot of supportive factors for more corporate activity, we think we have further to go.

Vishy Tirupattur: On that point, Andrew, I think if you look at the LBOs that are happening today versus the LBOs that happened in the 2007 era, the equity contribution is dramatically different. You know, equity to debt, these LBOs that are happening today [are] of a substantially higher amount of equity contribution compared to the LBOs we saw pre-Financial Crisis…

Andrew Sheets: That's such a great point. And the listener may not know this, but Vishy and I were working together at Morgan Stanley prior to the Financial Crisis, and we were working in credit research when a lot of these LBOs were happening, and…

Vishy Tirupattur: And I used to be tall and good looking.

Andrew Sheets: (laughs) And they were just very different. We're still not there. If you go back and pull the numbers, you're looking at transactions still that are far more conservative than what we saw then. So, you know, this activity is cyclical, and I think we do have to watch deregulation, right? You saw a lot of regulations come in after the Financial Crisis that led to more conservative lending. If those regulations get rolled back, we could really move back towards more aggressive lending. But we haven't quite seen that yet.

Vishy Tirupattur: Absolutely not.

Andrew Sheets: And Vishy, maybe the third question that comes up a lot. We've covered private credit, which is very topical. We've covered kind of corporate aggressiveness. But maybe the icing on the cake. The biggest question is AI – and is AI spending?

And it just feels like every day you come into the office and there's another headline on CNBC or Bloomberg about another mega AI funding deal. And the question is, okay, where's all that money going to come from?

And maybe some of it comes from these companies themselves. They’re very profitable, but credit might have to fill in some of the gaps. And you and some of our colleagues have done a lot of work on this. Where do you think kind of the lending story and the borrowing story fits into this broader AI theme?

Vishy Tirupattur: Our estimate of simply data center related CapEx requirements are close to $3 trillion. You add the power required for the data centers and add another $300-400 billion. So, a lot of this CapEx will come from – roughly about half might come from the operating cash flows of the hyperscalers. But the rest, so [$]1.5 trillion plus, has to come through various channels of credit.

So, unsecured corporate credit, we think will play a fairly small role in this. Of that [$]1.5 trillion plus, maybe [$]200 billion to come from unsecured credit issuance by these hyperscalers, and perhaps some of the securitized markets, such as ABS and CMBS that rely on stabilized cash flows may be another 1[$]50 billion. But a different version of private credit, what we will call ABF or asset based finance, will play a very big role. So north of [$]800 billion we think will come from that kind of a private credit version of investment grade, or a private credit markets developing. So, this market is very much in the developmental mode.

So, one way or the other, for AI to go from where it is today to substantially improving productivity and the earnings of companies that has to go through CapEx; and that CapEx needs to go through credit markets.

Andrew Sheets: And I think that is so fascinating because, right Vishy, so much of the spending is still ahead of us. It hasn't even really started, if you look at the numbers.

Vishy Tirupattur: Absolutely. We are in the early stages of this CapEx cycle. We should expect to see a lot more CapEx and that CapEx train has to run through credit markets.

Andrew Sheets: So, Vishy, there's obviously a lot of history in financial markets of larger CapEx booms, and some of them work out well, and some of them don't. I mean, if you are trying to think about some of the dynamics of this funding for AI and data centers more broadly versus some of these other CapEx cycles that investors might be familiar with. Are there some similar dynamics and some key differences that you try to keep in mind?

Vishy Tirupattur: So, in terms of similarities, you know, they're big numbers, whichever way you cut it, these numbers are going to be big dollar numbers.

But there are substantial differences between the most recent CapEx boom that we saw towards the end of the late 90s, early 2000s; we saw a massive telecom boom, telecom related CapEx. The big difference is that spending was done by – predominantly by companies that had put debt on their balance sheet. They were already very leveraged. They were just barely investment grade or some below investment grade companies with not much cash on their balance sheet.

And you contrast that with today's world, much of this is being done by highly rated companies; the hyperscalers or between, you know, A+ to AAA rated companies, with a lot of cash on their balance sheets and with very little outstanding debt on their part.

On top of that, the kind of channels that exist today, you know, data center, ABS and CMBS, asset-based finance, joint venture kind of financing. All of these channels were simply not available back then. And the fact that they all are available today means that this risk of CapEx is actually much more widely distributed.

So that makes me feel a lot better about the evolution of this CapEx cycle compared to the most recent one we saw.

Andrew Sheets: Private credit, a rise in M&A and a very active funding market for AI. Three big topics that are defining the credit debate today. Vishy, thanks for taking the time to talk.

Vishy Tirupattur: Andrew, always fun to hang with you.

Andrew Sheets: And thank you for listening. If you enjoy Thoughts on the Market, please leave us review wherever you listen and tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today, a look at the first bond that Morgan Stanley helped issue 90 years ago and what it might tell us about market uncertainty.

It's Thursday, October 9th at 4pm in London.

In times of uncertainty, it's common to turn to history. And this we think also applies to financial markets. The Great Depression began roughly 95 years ago. Of its many causes, one was that the same banks that were shepherding customer deposits were also involved in much riskier and more volatile financial market activity.

And so, when the stock market crashed, falling over 40 percent in 1929, and ultimately 86 percent from a peak to a trough in 1932, unsuspecting depositors often found their banks overwhelmed by this market maelstrom.

The Roosevelt administration took office in March of 1933 and set about trying to pick up the pieces. Many core aspects that we associate with modern financial life from FDIC insurance to social security to the somewhat unique American 30-year mortgage rose directly out of policies from this administration and the financial ashes of this period.

There was also quite understandably, a desire to make banking safer. And so the Glass Steagall Act mandated that banks had a choice. They could either do the traditional deposit taking and lending, or they could be active in financial market trading and underwriting. In response to these new separations, Morgan Stanley was founded 90 years ago in 1935 to do the latter.

It was a very uncertain time. The U.S. economy was starting to recover under President Roosevelt's New Deal policies, but unemployment was still over 17 percent. Europe's economy was struggling, and the start of the Second World War would be only four years away. The S&P Composite Equity Index, which currently sits at a level of around 6,700, was at 12.

It was into this world that Morgan Stanley brought its first bond deal, a 30-year corporate bond for a AA rated U.S. utility. And so, listeners, what do you think that that sort of bond yielded all those years ago?

Luckily for us, the good people at the Federal Reserve Bank of St. Louis digitized a vast array of old financial newspapers. And so, we can see what the original bond yielded in the announcement. The first bond, Morgan Stanley helped issue with a 30-year maturity and a AA rating had a yield of just 3.55 percent. That was just 70 basis points over what a comparable U.S. treasury bond offered at the time.

Anniversaries are nice to celebrate, but we think this example has some lessons for the modern day. Above anything, it's a clear data point that even in very uncertain economic times, high quality corporate bonds can trade at very low spreads – much lower than one might intuitively expect.

Indeed, the extra spread over government bonds that investors required for a 30-year AA rated utility bond 90 years ago, in the immediate aftermath of the Great Depression is almost exactly the same as today.

It's one more reason why we think we have to be quite judicious about turning too negative on corporate credit too early, even if the headline spreads look low.

Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also, please tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today, a look at the forces that could heat up corporate activity in 2026 – if the labor market can hold up.

It's Monday, September 29th at 2pm in London.

Bill Martin, a former chairman of the Federal Reserve in the 50’s and 60’s, famously joked that “it was the Fed's job to take away the punch bowl just when the party is getting good.”

That quote seems relevant because a host of trends are pointing to a pretty lively scene over the next 12 months. First, the U.S. government is spending significantly more than it's taking in. This deficit running at about 6.5 percent of the size of the whole economy is providing stimulus. It's only been larger during the great financial crisis, COVID and World War II. It's punch.

Next to the corporate sector. As you've heard us discuss on this podcast, we here at Morgan Stanley think that AI related spending could amount to one of the largest waves of investment ever recorded – dwarfing the shale boom of the 2010s and the telecommunication spending of the late 1990s.  Importantly, we think this spending is ramping up right now. Morgan Stanley estimates that investments by large tech companies will increase by 70 percent this year, and between 2024 and 2027, we think this spending is going to go up by two and a half times. Note that this doesn't even account for the enormous amount of power and electricity infrastructure that's going to be need to be built to support all this. Hence more economic punch.

Finally, there's a deregulatory push. My bank research colleagues believe that lower capital requirements for U.S. banks could boost their balance sheet capacity by an additional $1 trillion in risk weighted terms. And a more supportive regulatory environment for mergers should help activity there continue to grow. Again, more punch.

Heavy government spending, heavy corporate spending, more bank lending and risk taking capacity. And what's next from the Federal Reserve? Well, they're not exactly taking the punch away. We think that the Fed is set to cut rates five more times to a midpoint of two and 7/8ths.

The Fed's supportive efforts are based on a real fear that labor markets are already starting to slow, despite the other supportive factors mentioned previously. And a broad weakening of the economy would absolutely warrant such support from the Fed.

But if growth doesn't slow – large deficits, booming capital expenditure, a looser regulatory environment, and now Fed rate cuts – would all support even more corporate risk taking possibly in a way that we haven't seen since the 1990s. For credit, that boom would be preferable to a sharp slowing of the economy, but it comes with its own risks.

Expect talk of this scenario next year to grow if economic data does hold up.

Thanks as always for listening. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today – a Fed that looks willing to let the economy run hot, and why this could help the case for credit overseas.

It's Friday, September 19th at 2pm in London.

Earlier this week, the Federal Reserve lowered its target rate by a quarter of a percent, and signaled more cuts are on the way. Yet as my colleagues Michael Gapen and Matt Hornbach discussed on this program yesterday, this story is far from straightforward. The Fed is lowering interest rates to support the economy despite currently low unemployment and elevated inflation.

The justification for this in the Fed's view is a risk that the job market may be set to weaken going forward. And so, it's better to err on the side of providing more support now; even if that support raises the chances that inflation could stay somewhat higher for somewhat longer. Indeed, the Fed's own economic projections bear out this willingness to err on the side of letting the economy run a bit hot. Relative to where they were previously, the Fed's latest assessment sees future economic growth higher, inflation higher, and unemployment lower. And yet, in spite of all this, they also see themselves lowering interest rates faster.

If the labor market is really set to weaken – and soon – the Fed's shift to provide more near-term support is going to be more than justified. But if growth holds up, well, just think of the backdrop. At present, we have bank loan growth accelerating, inflation that's elevated, government borrowing that's large, stock valuations near 30-year highs, and credit spreads near 30-year lows. And now the Fed's going to lower interest rates in quick succession? That seems like a recipe for things to heat up pretty quickly.

It's also notable that the Fed's strategy is not necessarily shared by its cross-Atlantic peers. Both the United Kingdom and the Euro area also face slowing labor markets and above target inflation. But their central banks are proceeding a lot more cautiously and are keeping rates on hold, at least for the time being.

A Fed that's more tolerant of inflation is bad for the U.S. dollar in our view, and my colleagues expect it to weaken substantially against the euro, the pound, and the yen over the next 12 months. And for credit, an asset that likes moderation, a U.S. economy increasingly poised between scenarios that look either too hot or too cold is problematic.

So, just maybe we can put the two together. What if a U.S. investor simply buys a European bond?

The European market would seem less inclined to these greater risks of conditions being too hot or too cold. It gives exposure to currencies backed by central banks that are proceeding more cautiously when faced with inflation. With roughly 3 percent yields on European investment grade bonds, and Morgan Stanley's forecast that the euro will rise about 7 percent versus the dollar over the next year, this seemingly sleeping market has a chance to produce dollar equivalent returns of close to 10 percent.

For U.S. investors, just make sure to keep the currency exposure unhedged.

Thank you as always for listening. If you find Thoughts to the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.

Welcome to Thoughts on the Market. I'm Andrew Sheets, head of Corporate Credit Research at Morgan Stanley.

Today, the narrow economic path the markets face as we come back from summer.

It's Thursday, September 4th at 2:00 PM in London.

September is a month of change and one of my favorite times of the year, the weather gets just a little crisper. Kids go back to school. Football, both kinds, are back on tv. And financial markets return from the summer in earnest, quickly ramping back up to full speed. This year, September brings a number of robust debates that we'll be covering on this podcast, but chief among these might be exactly how strong or not investors actually want the economy to be.

You see at the moment, the Federal Reserve is set to lower interest rates, and they're set to do that even though inflation in the US is still well above target and it's moving higher. That's unusual and it's made even more unusual in the context of financial conditions being very easy and the US government borrowing a historically large amount of money.

The Fed's reason to lower interest rates despite strong markets, elevated inflation and high budget deficits, is the concern that the US labor market is weakening. And this fear is not unfounded. US job growth has recently slowed sharply. In 2023 and 2024, the US was adding on average about 200,000 jobs every month. But this year job growth has been less than half that amount, just 85,000 per month. And the most recent data's even worse. Tomorrow brings another important update. But here's the rub: the Fed, in theory, is lowering rates because the labor market is weaker. Markets would like those lower rates, but investors would not like a significantly weaker economy.

And this logic is born out pretty starkly in history. When the Fed is lowering interest rates as growth holds up, that represents some of the best ever market environments, including the mid 1990s. But when the Fed lowers rates as the economy weakens well, that represents some of the worst. So as the leaves start to turn and the air gets a little chilly, this is the fine line that markets face coming back into September. Weaker data for the labor market would make it easier to justify Fed cuts, but would make the broader backdrop more historically challenging. Stronger data could make the Fed look offsides, committing to lower interest rates despite high and rising inflation, easy financial conditions, and what would be a still resilient economy. And that could unleash even more aggressiveness and animal spirits.

Stock markets might like that aggressiveness, but neither outcome is great for credit. And so by process of elimination, our market is hoping for something moderate, belt high, and over the middle of the plate. Our economists forecast for this Friday's jobs report for about 70,000 jobs, and a stable unemployment rate would fit that moderate bill. But for this month and now for the rest of the year, we'll be walking a narrow economic path.

Thank you as always for your time. If you find Thoughts of the Market useful, let us know by leaving a review wherever you listen, and also tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today – the big difference between our view and the market on what the Fed will do next month; and how that impacts our credit view.

It's Thursday, August 14th at 2pm in London.

As of this recording, the market is pricing in a roughly 97 percent chance that the Federal Reserve lowers interest rates at its meeting next month. But our economists think it remains more likely that they will leave this rate unchanged. It's a big divergence on a very important market debate.

But what may seem like a radical difference in view is actually, in my opinion, a pretty straightforward premise. The Federal Reserve has a so-called dual mandate tasked with keeping both inflation and unemployment low.

The unemployment rate is low, but the inflation rate – importantly – is not. In order to ensure that that inflation rate goes lower, absent a major weakening of the economy, we think it would be reasonable for the Fed to keep interest rates somewhat higher for somewhat longer. Hence, we forecast that the Fed will end up staying put at its September meeting.

Indeed, while the market rallied on this week's latest inflation numbers, they still leave the Fed with some pretty big questions. Core inflation in the US is above the Fed's target. It's been stuck near these levels now for more than a year. And based on this week's latest data, it started to actually tick up again, a trend that we think could continue over the next several readings as tariff impacts gradually come through.

And so, for credit, this presents three scenarios. One good, and two that are more troubling.

The good scenario is that our forecasts for inflation are simply too high. Inflation ends up falling faster than we expect even as the economy holds up. That would allow the Fed to lower interest rates sooner and faster than we're forecasting. And this would be a good scenario for credit, even at currently low rich spreads, and would likely drive good total returns.

Scenario two sees inflation elevated in line with our near-term forecast, but the Fed lowers rates anyway. But wouldn't this be good? Wouldn't the credit market like lower rates? Well, lowering rates stimulates the economy and tends to push inflation higher, all else equal. And so, with inflation still above where the Fed wants it to be, it raises the odds of a hot economy with faster growth, but higher prices.

That sort of mix might be welcomed by the equity market, which can do better in those booming times. But that same environment tends to be much tougher for credit. And if inflation doesn't end up falling as the Fed cuts rates, well, the Fed may be forced to do fewer rate cuts overall over the next one or two years. Or, even worse, may even have to reverse course and resume hikes – more volatile paths that we don't think the credit market would like.

A third scenario is that a forecast at Morgan Stanley for growth, inflation, and the Fed are all correct. The central bank doesn't lower interest rates next month despite currently widespread expectation that they do so. That scenario could still be reasonable for the credit market over the medium term, but it would represent a very big surprise – not too far away, relative to market expectations.

For now, markets may very well return to a late August slumber. But we're mindful that we're expecting something quite different than others when that summer ends.

Thank you as always, for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.

Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today – how a tricky two months could feel a lot like stagflation, and a lot different from what we’ve had so far this year.

It’s Thursday, August 7th, at 2pm in London.

For all the sound and fury around tariffs in 2025, financial markets have been resilient. Stocks are higher, bond yields are lower, credit spreads are near 20-year tights, and market volatility last month plummeted.

Indeed, we sense increasing comfort with the idea that markets were tested by tariffs – after all we’ve been talking about them since February – and weathered the storm. So far this year, growth has generally held up, inflation has generally come down, and corporate earnings have generally been fine.

Yet we think this might be a bit like a wide receiver celebrating on the 5-yard line. The tricky impact of tariffs? Well, it might be starting to show up in the data right now, with more to come over the next several months.

When thinking about the supposed risk from tariffs, it’s always been two fold: higher prices and then also less activity, given more uncertainty for businesses, and thus weaker growth.

And what did we see last week? Well, so-called core-PCE inflation, the Fed’s preferred inflation measure, showed that prices were once again rising and at a faster rate. A key report on the health of the U.S. jobs market showed weak jobs growth. And key surveys from the Institute of Supply Management, which are followed because the respondents are real people in the middle of real supply chains, cited lower levels of new orders, and higher prices being paid.

In short, higher prices and slower growth. An unpleasant combo often summarized as stagflation.

Now, maybe this was just one bad week. But it matters because it is coming right about the time that Morgan Stanley economists think we’ll see more data like it. On their forecasts, U.S. growth will look a lot slower in the second half of the year than the first. And specifically, it is in the next three months, which should show higher rates of month-over-month inflation, while also seeing slower activity.

This would be a different pattern of data that we’ve seen so far this year. And so if these forecasts are correct, it’s not that markets have already passed the test. It's that the teacher is only now handing it out. 

For credit, we think this could make the next several months uncomfortable and drive some modest spread widening. Credit still has many things going for it, including attractive yields and generally good corporate performance. But this mix of slower growth and higher inflation, well, it’s new. It’s coming during an August/September period, which is often somewhat more challenging for credit. And all this leads us to think that a strong market will take a breather.

Thank you, as always, for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today – how the world may fund $3 trillion of expected spending on AI.

It's Friday July 25th at 2pm in London.

Whether you factor it in or not, AI is rapidly becoming a regular part of our daily lives. Checking the weather before you step out of the house. Using your smartphone to navigate to your next destination, with real time traffic updates. Writing that last minute wedding speech. An app that reminds you to take your medication or maybe reminds you to power off your device.

All of these capabilities require enormous physical infrastructure, from chips to data centers, to the electricity to power it all. And however large AI is seen so far, we really haven't seen anything yet. Over the next five years, we think that global data center capacity increases by a factor of six times. The cost of this spending is set to be extraordinary. $3 trillion by the end of 2028 on just the data centers and their hardware alone.

Where will all this money come from?

In a recent deep dive report published last week, a number of teams within Morgan Stanley Research attempted to answer just that. First, large cap technology companies, which are also commonly called the hyperscalers. Well, they are large and profitable. We think they may fund half of the spending out of their own cash flows.

But that leaves the other half to come from outside sources. And we think that credit markets – corporate bonds, securitized credit, asset-backed finance markets – they're gonna have a large role to play, given the enormous sums involved.

For corporate bonds, the asset class closest to my heart, we estimate an additional $200 billion of issuance to fund these endeavors. Technology companies do currently borrow less than other sectors relative to their cash flow, and so we're starting from a relatively good place if you want to be borrowing more – given that they're a small part of the current bond market. While technology is over 30 percent of the S&P 500 Equity Index, it's just 10 percent of the Investment Grade Bond Index.

Indeed, a relevant question might be why these companies don't end up borrowing more through corporate bonds, given this relatively good starting position.

Well, some of this we think is capacity. The largest non-financial issuers of bonds today have at most $80 to $90 billion of bonds outstanding. And so as good as these big tech businesses are, asking investors to make them the largest part of the bond market effectively overnight is going to be difficult.

Some of our thinking is also driven by corporate finance. We are still in the early stages of this AI build out where the risks are the highest. And so, rather than take these risks on their own balance sheet, we think many tech companies may prefer partnerships that cost a bit more but provide a lot more flexibility. One such partnership that you'll likely to hear a lot more about is Asset Backed Finance or ABF. We see major growth in this area, and we think it may ultimately provide roughly $800 billion of the required funding.

The stakes of this AI build out are high. It's not hyperbole to say that many large tech companies see this race to develop AI technology as non-negotiable. The cost of simply competing in this race, let alone winning it – could be enormous. The positive side of this whole story is that we're in the early innings of one of the next great runs of productive capital investment, something that credit markets have helped fund for hundreds of years.

The risks, as can often be the case with large spending, is that more is built than needed; that technology does change, or that more mundane issues like there not being enough electricity change the economics of the endeavor.

AI will be a theme set to dominate the investment debate for years to come. Credit may not be the main vector of the story. But it's certainly a critical part of it.

Thank you as always, for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Today I'm going to talk about why tariffs are showing up everywhere – but the data; and why we think this changes this quarter.

It's Wednesday, July 16th at 2pm in London.

Investors have faced tariff headlines since at least February. The fact that it's now mid-July and markets are still grinding higher is driving some understandable skepticism that they're going to have their promised impact. Indeed, we imagine that maybe more of one of you is groaning and saying, ‘What? Another tariff episode?’

But we do think this theme remains important for markets. And above all, it's a factor we think is going to hit very soon. We think it's kind of now – the third quarter – when the promised impact of tariffs on economic data and earnings really start to come through.

My colleague Jenna Giannelli and I discussed some of the reasons why, on last week's episode focused on the retail sector. But what I want to do next is give a little bit of that a broader context.

Where I want to start is that it's really about tariff impact picking up right about now. The inflation readings that we got earlier this week started to show US core inflation picking up again, driven by more tariff sensitive sectors. And while second quarter earnings that are being reported right about now, we think will generally be fine, and maybe even a bit better than expected; the third quarter earnings that are going to be generated over the next several months, we think those are more at risk from tariff related impact. And again, this could be especially pronounced in the consumer and retail sector.

So why have tariffs not mattered so much so far, and why would that change very soon? The first factor is that tariff rates are increasing rapidly. They've moved up quickly to a historically high 9 percent as of today; even with all of the pauses and delays. And recently announced actions by the US administration over just the last couple of weeks could effectively double this rate again -- from 9 percent to somewhere between 15 to 20 percent.

A second reason why this is picking up now is that tariff collections are picking up now. US Customs collected over $26 billion in tariffs in June, which annualizes out to about 1 percent of GDP, a very large number. These collections were not nearly as high just three months ago.

Third, tariffs have seen pauses and delayed starts, which would delay the impact. And tariffs also exempted goods that were in transit, which can be significant from goods coming from Europe or Asia; again, a factor that would delay the impact. But these delays are starting to come to fruition as those higher tariff collections and higher tariff rates would suggest.

And finally, companies did see tariffs coming and tried to mitigate them. They ordered a lot of inventory ahead of tariff rates coming into effect. But by the third quarter, we think they've sold a lot of that inventory, meaning they no longer get the benefit. Companies ordered a lot of socks before tariffs went into effect. But by the third quarter and those third quarter earnings, we think they will have sold them all. And the new socks they're ordering, well, they come with a higher cost of goods sold.

In short, we think it's reasonable to expect that the bulk of the impact of tariffs and economic and earnings data still lies ahead, especially in this quarter – the third quarter of 2025. We continue to think that it's probably in August and September rather than June-July, where the market will care more about these challenges as core inflation data continues to pick up.

For credit, this leaves us with an up in quality bias, especially as we move through that August to September period. And as Jenna and I discussed last week, we are especially cautious on the retail credit sector, which we think is more exposed to these various factors converging in the third quarter.

Thank you as always for your time. If you find Thoughts on the Market useful, let us know by leaving a review wherever you listen; and also tell a friend or colleague about us today.

Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Head of Corporate Credit Research at Morgan Stanley.

Jenna Giannelli: And I'm Jenna Giannelli, Head of U.S. Consumer and Retail Credit Research.

Andrew Sheets: And today on the podcast, we're going to dig into one of the biggest conundrums in the market today. Where and when are tariffs going to show up in prices and margins?

It's Friday, July 11th at 10am in New York.

Jenna, it's great to catch up with you today because I think you can really bring some unique perspective into one of the biggest puzzles that we're facing in the market today. Even with all of these various pauses and delays, the U.S. has imposed historically large tariffs on imports. And we're seeing a rapid acceleration in the amount of money collected from those tariffs by U.S. customs. These are real hard dollars that importers – or somebody else – are paying. Yet we haven't seen these tariffs show up to a significant degree in official data on prices – with recent inflation data relatively modest. And overall stock and credit markets remain pretty strong and pretty resilient, suggesting less effect.

So, are these tariffs just less impactful than expected, or is there something else going on here with timing and severity? And given your coverage of the consumer and retail sectors, which is really at the center of this tariff debate – what do you think is going on?

Jenna Giannelli: So yes, this is a key question and one that is dominating a lot of our client conversations. At a high level, I'd point to a few things. First, there's a timing issue here. So, when tariffs were first announced, retailers were already sitting on three to four months worth of inventory, just due to natural industry lead times. And they were able to draw down on this product.

This is mostly what they sold in 1Q and likely into 2Q, which is why you haven't seen much margin or pricing impact thus far. Companies – we also saw them start to stock up heavily on inventory before the tariffs and at the lower pause rate tariffs, which is the product you referenced that we're seeing coming in now. This is really going to help mitigate margin pressure in the second quarter that you still have this lower cost inventory flowing through.

On top of this timing consideration, retailers – we've just seen utilizing a range of mitigation measures, right? So, whether it's canceled or pause shipments from China, a shifting production mix or sourcing exposure in the short run, particularly before the pause rate on China. And then really leaning into just whether it's product mix shifts, cost savings elsewhere in the PNL, and vendor negotiations, right? They're really leaning into everything in their toolbox that they can.

Pricing too has been talked about as something that is an option, but the option of last resort. We have heard it will be utilized, but very tactically and very surgically, as we think about the back half of the year. When you put this all together, how much impact is it having? On average from retailers that we heard from in the first quarter, they thought they would be able to mitigate about half of the expected tariff headwind, which is actually a bit better than we were expecting.

Finally, I'll just comment on your comment regarding market performance. While you're right in that the overall equity and credit markets have held up well, year-to-date, retail equities and credit have fared worse than their respective indices. What's interesting, actually, is that credit though has significantly outperformed retail equities, which is a relationship we think should converge or correct as we move throughout the balance of the year.

Andrew Sheets: So, Jenna, retailers saw this coming. They've been pulling various levers to mitigate the impact. You mentioned kind of the last lever that they want to pull is prices, raising prices, which is the macro thing that we care about. The thing that would actually show up in inflation.

How close are we though to kind of running out of other options for these guys? That is, the only thing left is they can start raising prices?

Jenna Giannelli: So closer is what I would say. We're likely not going to see a huge impact in 2Q, more likely as we head into 3Q and more heavily into the all-important fourth quarter holiday season. This is really when those higher cost goods are going to be flowing through the PNL and retailers need to offset this as they've utilized a lot of their other mitigation strategies. They've moved what they could move. They've negotiated where they could, they've cut where they could cut. And again, as this last step, it will be to try and raise price.

So, who's going to have the most and least success? In our universe, we think it's going to be more difficult to pass along price in some of the more historically deflationary categories like apparel and footwear. Outside of what is a really strong brand presence, which in our universe, historically hasn't been the case.

Also, in some of the higher ticket or more durable goods categories like home goods, sporting goods, furniture, we think it'll be challenging as well here to pass along higher costs. Where it's going to be less of an issue is in our Staples universe, where what we'd put is less discretionary categories like Beauty, Personal Care, which is part of the reason why we've been cautious on retail, and neutral and consumer products when we think about sector allocation.

Andrew Sheets: And when do you think this will show up? Is it a third quarter story? A fourth quarter story?

Jenna Giannelli: I think this is going to really start to show up in the third quarter, and more heavily into the fourth quarter, the all-important holiday season.

Andrew Sheets: Yeah, and I think that’s what’s really interesting about the impact of this backup to the macro. Again, returning to the big picture is I think one of the most important calls that Morgan Stanley economists have is that inflation, which has been coming down somewhat so far this year is going to pick back up in August and September and October. And because it's going to pick back up, the Federal Reserve is not going to cut interest rates anymore this year because of that inflation dynamic.

So, this is a big debate in the market. Many investors disagree. But I think what you're talking about in terms of there are some very understandable reasons, maybe why prices haven't changed so far. But that those price hikes could be coming have real macroeconomic implications.

So, you know, maybe though, something to just close on – is to bring this to the latest headlines. You know, we're now back it seems, in a market where every day we log onto our screens, and we see a new headline of some new tariff being announced or suggested towards countries. Where do you think those announcements, so far are relative to what retailers are expecting – kind of what you think is in guidance?

Jenna Giannelli: Sure. So, look what we've seen of late; the recent tariff headlines are certainly higher or worse, I think, than what investors in management teams were expecting. For Vietnam, less so; I'd say it was more in line. But for most elsewhere, in Asia, particularly Southeast Asia, the rates that are set to go in effect on August 1st, as we now understand them, are higher or worse than management teams were expecting.

Recall that while guidance did show up in many flavors in the first quarter, so whether withdrawn guidance or lowered guidance. For those that did factor in tariffs to their guide, most were factoring in either pause rate tariffs or tariff rates that were at least lower than what was proposed on Liberation Day, right?

So, what's the punchline here? I think despite some of the revisions we've already seen, there are more to come. To put some numbers around this, if we look at our group of retail consumer cohort, credits, consensus expectations for calling for EBITDA in our universe to be down around 5 percent year-over-year. If we apply tariff rates as we know them today for a half-year headwind starting August 1st, this number should be down around 15 percent year-over-year on a gross basis…

Andrew Sheets: So, three times as much.

Jenna Giannelli: Pretty significant. Exactly. And so, while there might be mitigation efforts, there might be some pricing passed along, this is still a pretty significant delta between where consensus is right now and what we know tariff rates to be today – could imply for earnings in the second half.

Andrew Sheets: Jenna, thanks for taking the time to talk.

Jenna Giannelli: My pleasure. Thank you.

Andrew Sheets: And thank you as always for your time. If you find Thoughts to the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.