America’s Debt Story

Matt Hornbach: Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy.

Michael Gapen: And I'm Michael Gapen, Morgan Stanley's Chief U.S. Economist.

Matt Hornbach: Today we're discussing the outcome of the June Federal Open Market Committee meeting and our expectations for rates, inflation, and the U.S. dollar from here.

It's Thursday, June 26th at 10am in New York.

Matt Hornbach: Mike, the Federal Reserve decided to hold the federal funds rate steady, remaining within its target range of 4.25 to 4.5 percent. It still anticipates two rate cuts by the end of 2025; but participants adjusted their projections further out suggesting fewer cuts in 2026 and 2027.

You, on the other hand, continue to think the Fed will stay on hold for the rest of this year, with a lot of cuts to follow in 2026. What specifically is behind your view, and are there any underappreciated dynamics here?

Michael Gapen: So, we've been highlighting three reasons why we think the Fed will cut late but cut more. The first is tariffs introduce differential timing effects on the economy. They tend to push inflation higher in the near term and they weaken consumer spending with a lag. If tariffs act as a tax on consumption, that tax is applied by pushing prices higher – and then only subsequently do consumers spend less because they have less real income to spend. So, we think the Fed will be seeing more inflation first before it sees the weaker labor market later.

The second part of our story is immigration. Immigration controls mean it's likely to be much harder to push the unemployment rate higher. That's because when we go from about 3 million immigrants per year down to about 300,000 – that means much lower growth in the labor force. So even if the economy does slow and labor demand moderates, the unemployment rate is likely to remain low. So again, that's similar to the tariff story where the Fed's likely to see more inflation now before it sees a weaker labor market later.

And third, we don't really expect a big impulse from fiscal policy. The bill that's passed the house and is sitting in the Senate, we’ll see where that ultimately ends up. But the details that we have in hand today about those bills don't lead us to believe that we'll have a big impulse or a big boost to growth from fiscal policy next year.

So, in total the Fed will see a lot of inflation in the near term and a weaker economy as we move into 2026. So, the Fed will be waiting to ensure that that inflation impulse is indeed transitory, but a Fed that cuts late will ultimately end up cutting more.

So we don't have rate hikes this year, Matt, as you noted. But we do have 175 basis points in rate cuts next year.

Matt Hornbach: So, Mike, looking through the transcript of the press conference, the word tariffs was used almost 30 times. What does the Fed's messaging say to you about its expectations around tariffs?

Michael Gapen: Yeah, so it does look like in this meeting, participants did take a stand that tariffs were going to be higher, and they likely proceeded under the assumption of about a 14 percent effective tariff rate. So, I think you can see three imprints that tariffs have on their forecast.

First, they're saying that inflation moves higher, and in the press conference Powell said explicitly that the Fed thinks inflation will be moving higher over the summer months. And they revised their headline and core PCE forecast higher to about 3 percent and 3.1 percent – significant upward revisions from where they had things earlier in the year in March before tariffs became clear. The second component here is the Fed thinks any inflation story will be transitory. Famous last words, of course. But the Fed forecast that inflation will fall back  towards the 2 percent target in 2026 and 2027; so near-term impulse that fades over time. And third, the Fed sees tariffs as slowing economic growth. The Fed revised lower its outlook for growth in real GDP this year. So, in some [way], by incorporating tariffs and putting such a significant imprint on the forecast, the Fed's outlook has actually moved more in the direction of our own forecast.

Matt Hornbach: I'd like to stay on the topic of geopolitics. In contrast to the word tariffs, the words Middle East only was mentioned three times during the press conference. With the weekend events there, investor concerns are growing about a spike in oil prices. How do you think the Fed will think about any supply-driven rise in energy, commodity prices here?

Michael Gapen: Yeah, I think the Fed will view this as another element that suggests slower growth and stickier inflation. I think it will reinforce the Fed's view of what tariffs and immigration controls do to the outlook. Because historically when we look at shocks to oil prices in the U.S.; if you get about a 10 percent rise in oil prices from here, like another $10 increase in oil prices; history would suggest that will move headline inflation higher because it gets passed directly into retail gasoline prices. So maybe a 30 to 40 basis point increase in a year-on-year rate of inflation. But the evidence also suggests very limited second round effects, and almost no change in core inflation.

So, you get a boost to headline inflation, but no persistence elements – very similar to what the Fed thinks tariffs will do. And of course, the higher cost of gasoline will eat into consumer purchasing power. So, on that, I think it's another force that suggests a slower growth, stickier inflation outlook is likely to prevail.

Okay Matt, you've had me on the hot seat. Now it's your turn. How do you think about the market pricing of the Fed's policy path from here? It certainly seems to conflict with how I'm thinking about the most likely path.

Matt Hornbach: So, when we look at market prices, we have to remember that they are representing an average path across all various paths that different investors might think are more likely than not. So, the market price today, has about 100 basis points of cuts by the end of 2026. That contrasts both with your path in terms of magnitude. You are forecasting 175 basis points of rate cuts; the market is only pricing in 100. But also, the market pricing contrasts with your policy path in that the market does have some rate cuts in the price for this year, whereas your most likely path does not.

So that's how I look at the market price. You know, the question then becomes, where does it go to from here? And that's something that we ultimately are incorporating into our forecasts for the level of Treasury yields.

Michael Gapen: Right. So, turning to that, so moving a little further out the curve into those longer dated Treasury yields. What do you think about those? Your forecast suggests lower yields over the next year and a half. When do you think that process starts to play out?

Matt Hornbach: So, in our projections, we have Treasury yields moving lower, really beginning in the fourth quarter of this year. And that is to align with the timing of when you see the Fed beginning to lower rates, which is in the first quarter of next year. So, market prices tend to get ahead of different policy actions, and we expect that to remain the case this year as well. As we approach the end of the year, we are expecting Treasury yields to begin falling more precipitously than they have over recent months.

But what are the risks around that projection? In our view, the risks are that this process starts earlier rather than later. In other words, where we have most conviction in our projections is in the direction of travel for Treasury yields as opposed to the timing of exactly when they begin to fall. So, we are recommending that investors begin gearing up for lower Treasury yields even today. But in our projections, you'll see our numbers really begin to fall in the fourth quarter of the year, such that the 10-year Treasury yield ends this year around 4 percent, and it ends 2026 closer to 3 percent.

Michael Gapen: And these days it's really impossible to talk about movements in Treasury yields without thinking about the U.S. dollar. So how are you thinking about the dollar amidst the conflict in the Middle East and your outlook for Treasury yields?

Matt Hornbach: So, we are projecting the U.S. dollar will depreciate another 10 percent over the next 12 to 18 months. That's coming on the back of a pretty dramatic decline in the value of the dollar in the first six months of this year, where it also declined by about 10 percent in terms of its value against other currencies.

So, we are expecting a continued depreciation, and the conflict in the Middle East and what it may end up doing to the energy complex is a key risk to our view that the dollar will continue to depreciate, if we end up seeing a dramatic rise in crude oil prices. That rise would end up benefiting countries, and the currencies of those countries who are net exporters of oil; and may end up hurting the countries and the currencies of the countries that are net importers of oil. The good news is that the United States doesn't really import a lot of oil these days, but neither is it a large net exporter either.

So, the U.S. in some sense turns out to be a bit of a neutral party in this particular issue. But if we see a rise in energy prices that could benefit other currencies more than it benefits the U.S. dollar. And therefore, we could see a temporary reprieve in the dollar’s depreciation, which would then push our forecast perhaps a little bit further into the future.

So, with that, Mike, thanks for taking the time to talk.

Michael Gapen: It's great speaking with you, Matt.

Matt Hornbach: And thanks for listening. If you enjoy thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.

Welcome to Thoughts on the Market. I’m Jonathan Garner, Morgan Stanley’s Chief Asia Equity Strategist. Today I’ll discuss why we remain positive on India’s long-term equity story.

It’s Tuesday, the 24th of June at 9am in Singapore.

We’ve had a long-standing bullish outlook on the India economy and its stock market. In the last five years MSCI India has delivered a total return in U.S. dollars of 145 percent versus 94 percent for global equities and just 39 percent for emerging markets. Indian equities are our most preferred market within Asia for three key reasons. First, India’s superior economic and earnings growth. Second, lower exposure to trade tariffs. And third, a strong domestic investor base. And all of this adds up to structural outperformance not just in Asia but indeed globally, and with significantly lower volatility than peer group markets.

So let’s dive deeper. To start with – the macroeconomic backdrop. We expect India to account for 20 percent of overall incremental global GDP growth in the coming decade. Manufacturing competitiveness is improving thanks to bolstered infrastructure in power, ports, roads, freight transport systems as well as investments in social infrastructure such as water, sewage and hospitals.

Additionally, India's growing middle class offers market opportunities to companies across many product categories. There’s robust domestic consumption, a strong investment cycle led by public and private capital expenditure and continuing structural reforms, including in the legal sphere. GDP growth in the first quarter was more than 7 percent and our team expects over 6 percent in the medium term, which would be by far the highest of the major economies

Furthermore, we continue to expect robust corporate earnings growth. Since the end of COVID, MSCI India has delivered around 12 percent per annum [U.S.] dollar earnings per share growth versus low single digits for Emerging Markets overall. And we forecast 14 percent and 16 percent over the next two fiscal years. Growth drivers in the short term include an emerging private CapEx cycle, re-leveraging of corporate balance sheets, and a structural rise in discretionary consumption –  signaling increased business and consumer confidence, after last year’s elections.

Another key reason that we’re positive on India currently is its lower-than-average vulnerability to ongoing trade and tariff disputes between the U.S. and its trade partners. Exports of goods to the U.S. amount to only 2 percent of India’s GDP versus, for example, 10 percent in Thailand or 14 percent in Taiwan. And India’s total goods exports are only around 12 percent of GDP. Moreover, for the time being, India’s very large services sector’s exports are not exposed to tariff actions, and are actually early beneficiaries of AI adoption.

Finally, India’s strong individual stock ownership means that there’s persistent retail buying, which underpins the equity market. Systematic Investment Plan (SIP) flows driven by a young urbanizing population are making new highs, and in May amounted to over U.S.$3 billion. They provide consistent capital inflows. That means that this domestic bid on stocks is unlikely to fade anytime soon.

This provides a strong foundation for the market and supports valuations which are slightly above emerging market averages. It also means that its market beta to global equities are low and falling, approximately 0.4 versus 1.1 ten years ago. And price volatility is well below other emerging markets.  All told, making India an attractive play in volatile times.

Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.