No Summer Slowdown for Markets – Yet

Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. Thematic and Equity strategist at Morgan Stanley.

David Adams: And I'm Dave Adams, head of G10 FX Strategy here at Morgan Stanley.

Michelle Weaver: Our colleagues were recently on the show to talk about the impact of the weak dollar on European equities. And today we wanted to continue that conversation by looking at what a week U.S. dollar means for the U.S. equity market.

It's Thursday, July 17th at 2pm in London.

Morgan Stanley has a bearish view on the U.S. dollar. And this is something our chief global FX strategist James Lord spoke about recently on the show. But Dave, I want to go over the outlook again, since Morgan Stanley has a really differentiated view on this. Do you think the dollar will continue to depreciate during the remainder of the year?

David Adams: We do, and we do. We have been dollar bears this whole year, and it has been very out of consensus. But we do think the weakness will continue and our forecasts remain one of the most bearish on the street for the dollar.

The dollar has had its worst first half of the year since 1973, and the dollar index has fallen about 10 percent year to date, but we think we're at the intermission rather than the finale. The second act for the dollar weakening trend should come over the next 12 months as U.S. interest rates and U.S. growth rates converge to that of the rest of the world. And FX hedging of existing U.S. assets held by foreign investors adds further negative risk premium to the dollar. The result is that we're looking for yet another 10 percent drop in the dollar by the end of next year.

Michelle Weaver: That's really interesting and a differentiated view for Morgan Stanley. When I think about one of the key themes that we've been following this year, it's the multipolar world or a shift away from globalization to more localized spheres of influence. This is an important element to the dollar story.

How have tariffs impacted currency and your outlook?

David Adams: Tariffs play a key role in this framework. Tariffs have a positive impact on inflation, but a negative impact on U.S. growth. But the inflation impact comes faster and the negative impact on growth and employment that comes a bit later. This puts the Fed in a really tough spot and it's why our economists are pretty out of consensus in calling for both no cuts this year, and a much faster and deeper pace of cuts in 2026.

The results for me in FX land is that the market is underestimating just how low the Fed will go and just how low U.S. rates will go. In general, tariffs play a big role in helping to generate this rate convergence, and rate differentials are a fundamental driver of currencies. The more that U.S. rates are going to fall, the more likely it is that the dollar keeps falling too.

Michelle Weaver: Tariffs have certainly impacted heavily on our view for the U.S. equity market and it, it's something that no asset class is, is not impacted by really given the volatility and the magnitude of the move we've seen this year.

Are foreign investors hedging more?

David Adams: We do think they've started hedging more, but the bulk of the move is really ahead of us. Foreign investors own a massive amount of U.S. assets. European investors alone own $8 trillion of U.S. bonds and stocks, and that's only about a quarter of total foreign ownership of U.S. assets.

Now when foreign investors buy U.S. assets, they have to sell their currency and buy the dollar. But at some point, you're going to have to bring that money back, so you're going to have to sell the dollar and buy back your home currency again. If the dollar rises over this period, you've made a gain, congratulations. But if it falls, you've made a loss.

Now a lot of foreign investors will hedge this currency risk, and they'll use instruments like forwards and options to do so. But in the case of the U.S., we found that a lot of foreign investors really choose not to hedge this exposure, particularly on the equity side. And this reflects both a view that the dollar would appreciate. So, they want to take that gain, but it also reflects the dollar's negative correlation to equities.

So, what's changing now? Well, a lot of investors are starting to rethink this decision and add those FX hedges, which really means dollar selling. Now, there's a lot of factors motivating their decision to hedge. One, of course is price. If U.S. rates are going to converge meaningfully to the rest of the world – like we expect – that flattens out the forward curve and makes those forwards cheaper to buy to hedge.

But the breakdown in correlations that we've seen more broadly, the uptick in policy volatility and uncertainty, and the sell off in the dollar that we've already seen year to date, have all increased the relative benefit of FX hedging.

Now, Michelle, I often get asked the question, that's a nice story, but is hedging actually picking up? And the answer is yes. The initial data suggests that hedging has picked up in the second quarter, but because of the size of U.S. asset holdings and given how much it was initially unhedged, we could be talking about a significant long-term flow. We have a lot more to go from here.

We estimated that just over half of Europe's $8 trillion holdings are unhedged. And if hedge ratios pick up even a little bit, we could be talking about hundreds of billions of dollars in flow. And that's just from Europe.

But Michelle, I wanted to ask you. What do you think a weaker dollar means for U.S. companies?

Michelle Weaver: The weaker dollar is a substantial underappreciated tailwind for U.S. multinational earnings, and this is because these companies sell products overseas and then get paid in foreign currency. So, when the dollar's down, converting that foreign revenue back into dollars, gives them a nice boost, something that domestic only companies aren't going to benefit from. And this is called the translation effect.

Recently we've seen earnings revisions breadth, essentially a measure of whether analysts are getting more optimistic or pessimistic start to turn up after hitting typical cycle lows. And based on our house view for the dollar, there's likely more upside ahead based on that relationship for revisions over the next year.

David Adams: Interesting. Interesting. And is this something you're hearing about from companies on things like earnings calls?

Michelle Weaver: No, this dynamic isn't being highlighted much on earnings calls. Typically, companies talk about foreign exchange effects when the dollar's strengthening and provides a headwind for corporate earnings. But when we're in the reverse scenario like we are now with the dollar weakening and getting a boost to earnings, we tend to not hear as much discussion, which is why I called this an underappreciated tailwind.

And according to your team's forecast, we still have a substantial amount of weakening to go and thus a substantial amount of benefit for U.S. companies to go.

David Adams: Yeah, that makes sense. And who do you think benefits most from this dynamic? Are there any sectors or investment styles that look particularly good here?

Michelle Weaver: So generally, it's the large cap companies that stand to gain the most from this dynamic, and that's because they do more business overseas. If we look at foreign revenue exposure for different indices, around 40 percent of the S & P 500’s revenue comes from outside the U.S., while that's just 22 percent for the Russell 2000 small cap index. But the impact of a weaker dollar isn't the same across the board.

Foreign revenue exposure and earnings revision sensitivity to the dollar vary quite a bit, when we look at the sector and the industry group level. From a foreign

revenue exposure perspective, Tech Materials and Industrials have the highest foreign revenue exposure and thus can benefit a lot from that dynamic we've been talking about. When we look from an earnings revisions perspective, Capital Goods, Materials, Software and Tech Hardware have the most earnings revisions, sensitivity to a weaker dollar, so they could also benefit there.

David Adams: So, I guess this brings us to the million-dollar question that all of our listeners are asking. What do we do with this information? What does this mean for investors?

Michelle Weaver: So as the dollar, continues to weaken, investors should keep a close eye on the industries and companies poised to benefit the most – because in this multipolar world, currency dynamics are not just a macro backdrop, but an important driver of earnings and equity performance.

Dave, thank you for taking the time to talk.

And to our listeners, thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague 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.