As credit resilience weakens with a worsening fundamental
backdrop, our Head of Corporate Credit Research Andrew Sheets
suggests investors reconsider their portfolio quality.
Read more insights from Morgan Stanley.
----- Transcript -----
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 we think near term improvement may be temporary,
and thus an opportunity to improve credit quality.
It's Friday March 28th at 2pm in London.
In volatile markets, it is always hard to parse how much is
emotion, and how much is real change. As you would have heard
earlier this week from my colleague Mike Wilson, Morgan Stanley’s
Chief U.S. Equity Strategist, we see a window for short-term
relief in U.S. stock markets, as a number of indicators suggest
that markets may have been oversold.
But for credit, we think this relief will be
temporary. Fundamentals around the medium-term story are on
the wrong track, with both growth and inflation moving in
the wrong direction. Credit investors should use this respite to
improve portfolio quality.
Taking a step back, our original thinking entering 2025 was that
the future presented a much wider range of economic scenarios,
not a great outcome for credit per se, and some real slowing of
U.S. growth into 2026, again not a particularly attractive
outcome.
Yet we also thought it would take time for these risks
to arrive. For the economy, it entered 2025 with some pretty
decent momentum. We thought it would take time for any changes in
policy to both materialize and change the real economic
trajectory.
Meanwhile, credit had several tailwinds, including attractive
yields, strong demand and stable balance sheet metrics. And so we
initially thought that credit would remain quite resilient, even
if other asset classes showed more volatility.
But our conviction in that resilience from credit is weakening as
the fundamental backdrop is getting worse. Changes to U.S. policy
have been more aggressive, and happened more quickly than we
previously expected. And partly as a result, Morgan Stanley's
forecasts for growth, inflation and policy rates are all
moving in the wrong direction – with forecasts showing now weaker
growth, higher inflation and fewer rate cuts from the Federal
Reserve than we thought at the start of this year. And it’s not
just us. The Federal Reserve's latest Summary of Economic
Projections, recently released, show a similar expectation for
lower growth and higher inflation relative to the Fed’s prior
forecast path.
In short, Morgan Stanley’s economic forecasts point to rising
odds of a scenario we think is challenging: weaker growth, and
yet a central bank that may be hesitant to cut rates to support
the economy, given persistent inflation.
The rising risks of a scenario of weaker growth, higher inflation
and less help from central bank policy temper our enthusiasm to
buy the so-called dip – and add exposure given some modest recent
weakness. Our U.S. credit strategy team, led by Vishwas Patkar,
thinks that U.S. investment grade spreads are only 'fair', given
these changing conditions, while spreads for U.S. high yield and
U.S. loans should actually now be modestly wider through year-end
– given the rising risks.
In short, credit investors should try to keep powder dry, resist
the urge to buy the dip, and look to improve portfolio
quality.
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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