Our Head of Corporate Credit Research looks at the Fed’s approach
to rate cuts, seasonal trends and the US election to explain why
the next month represents a crucial window for credit’s
future.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Andrew Sheets, head of
Corporate Credit Research at Morgan Stanley. Along with my
colleagues bringing you a variety of perspectives, today I'll
discuss why the next month is a critical window for credit.
It's Thursday, September 12th at 9am in New York.
We’ve liked corporate credit as an asset class this year and
think the outlook over the next 6-12 months remains promising. At
a high level, credit likes moderation, and that continues to be
exactly what Morgan Stanley’s economists are forecasting; with
moderate growth, moderate inflation, and moderating policy in the
US and Europe. Meanwhile, at the ground level, corporate balance
sheets are in good shape, and demand for fixed income remains
strong, dynamics that we think are unlikely to shift
quickly.
But this good credit story is now facing a critical window. As
we’ve discussed recently on this program, the Fed has taken a
risk with monetary policy, continuing to keep interest rates
elevated despite increasing indications that they should be
lower. U.S. inflation has been coming down rapidly, to the point
where the market now thinks the rate of inflation over the next
two years will be below what the Fed is targeting. The labor
market is slowing, and government bond markets are now assuming
that the Fed will have to make much more significant adjustments
to policy.
And so, this becomes a race. If the economic data can hold up for
the next few months, while the Fed does make those first gradual
rate cuts, it will help reassure markets that monetary policy is
reasonable and in-line with the underlying economy. But if the
data weakens more now, the market is vulnerable. Monetary
policy works with a lag, meaning rate cuts are not going to help
anytime soon. And so, it becomes easier for the market to worry
that growth is slowing too much, and that the cavalry of rate
cuts will be too late to arrive.
The second immediate challenge is so-called seasonality. Over
almost a century, September has seen significantly weaker
performance relative to any other month. Seasonality always has
an element of mysticism to it, but in terms of specific reasons
why markets tend to struggle around this time of year, we’d point
to two factors. First, after a summer lull, you tend to see
a lot of issuance, including corporate bonds issuance.
And for Equities, September often sees more negative earnings
revisions, as companies aim to bring full-year estimates in line
with reality. Lots of supply and weaker earnings revisions are
often a tough combination.
A final element of this critical window is the approaching US
election. This appears to be an extremely
close race between candidates with very different policy
priorities. If investors get more nervous that monetary policy is
mis-calibrated, or seasonality is unhelpful, the approaching
election provides yet another reason for investors to hold
back.
All of this is why we think the next month is a critical window
for credit, and why we’d exercise a little bit more caution than
we have so far this year. But we also think any weakness is going
to be temporary. By early November, the US election will be over,
and we think growth will be holding up, inflation will keep
coming down, and interest rate cuts will be well underway. And
while September is historically a bad month for stocks and
credit, late-October onward is a different and much better story.
Any near-term softness could still give way to a stronger finish
to the year.
Thanks for listening. If you enjoy the show, leave us a review
wherever you listen and share Thoughts on the Market with a
friend or colleague today.
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