The Curious Calm of Credit Markets — Transcript

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1. 0:00Welcome to Thoughts on the Market. I'm
2. 0:02Andrew Sheets, Global Head of Fixed
3. 0:04Income Research at Morgan Stanley.
4. 0:07Today, how spooked should we be about
5. 0:10the credit markets?
6. 0:12It's Friday, October 30th at 2:00 p.m.
7. 0:14in London.
8. 0:18I grew up watching The Simpsons and I've
9. 0:21always had a soft spot for their
10. 0:22Halloween episodes.
11. 0:24One in particular that's burrowed pretty
12. 0:25deep in my memory involves a cursed
13. 0:27monkey's paw.
14. 0:29It technically granted wishes to whoever
15. 0:32held it, but with unintended
16. 0:34consequences. For example, Lisa wishes
17. 0:37for world peace,
18. 0:38the entire planet disarms, and then
19. 0:40aliens invade and take over.
20. 0:43That sort of thing.
21. 0:45Keep that monkey's paw in mind.
22. 0:47Credit markets are going through their
23. 0:49own jittery episode.
24. 0:51After a long period of support, central
25. 0:53banks are raising rates and shrinking
26. 0:55their balance sheets. Thanks in part to
27. 0:57the shift, global yields have risen, and
28. 0:59since bond prices move inversely to
29. 1:01yields, they've driven negative total
30. 1:03returns.
31. 1:04Then there's the AI boom, maybe the
32. 1:06defining economic story of 2026.
33. 1:09Morgan Stanley estimates that close to
34. 1:11$900 billion
35. 1:13of CapEx will happen this year, roughly
36. 1:15double what we saw last year and triple
37. 1:17the levels of 2024.
38. 1:19And we think this growth continues with
39. 1:21hyperscaler capital expenditures
40. 1:23reaching about 1 and 1/2 trillion
41. 1:25dollars next year,
42. 1:27almost the size of the entire US defense
43. 1:29budget.
44. 1:31All that spending requires financing,
45. 1:33and credit markets have been a key
46. 1:34source of it.
47. 1:36Heavy supply from this relatively new
48. 1:38sector, technology, has pushed up both
49. 1:40yields and spreads, especially because
50. 1:42these issuers have often been willing to
51. 1:44price their debt pretty cheaply relative
52. 1:47to the rating.
53. 1:49These higher yields haven't slowed down
54. 1:50the largest tech companies given their
55. 1:52considerable financial resources,
56. 1:54but it has caused ripples further down
57. 1:56the chain.
58. 1:57Lower-rated credits with more leverage
59. 1:59and slower growth are being more
60. 2:01impacted by these higher borrowing
61. 2:03costs.
62. 2:04And the presence of these new
63. 2:05technologies has increased fears of
64. 2:07disruption to existing business models,
65. 2:09especially in sectors like telecom.
66. 2:12And as a result, the dispersion between
67. 2:14credits has increased.
68. 2:16Scary stuff. Or is it?
69. 2:20If you'd spoken to a credit investor
70. 2:22over the last 10 to 15 years, you would
71. 2:24have heard a litany of wishes. If only
72. 2:27central banks stopped intervening in
73. 2:29markets compressing credit risk
74. 2:30premiums. If only yields weren't so low.
75. 2:34If only the growth backdrop was better.
76. 2:37These investors wished that the
77. 2:39technology sector would finally issue
78. 2:41bonds given its extremely low weight in
79. 2:43credit markets, which are heavily skewed
80. 2:45towards slower growing sectors like
81. 2:47banks, utilities, and telecom.
82. 2:49They wished for new bonds that were
83. 2:50highly rated, yet also would have high
84. 2:53spreads.
85. 2:54They wished for new issue premium, which
86. 2:56had compressed sharply.
87. 2:58And maybe, just maybe, in their wildest
88. 3:00dreams, they hoped they could get it
89. 3:02all. New bonds that were highly rated in
90. 3:05a fast-growing sector issued at a large
91. 3:07new issue premium, and hopefully, a lot
92. 3:10of it.
93. 3:11They also, from a business sense, wanted
94. 3:14dispersion.
95. 3:15The case for active credit management
96. 3:17relies on the idea that there are
97. 3:19differences in credit performance that a
98. 3:21skilled analyst can capture.
99. 3:23If everything just moves together, well,
100. 3:26just buy the index.
101. 3:28We got our wish.
102. 3:30Yields are high with investment-grade
103. 3:32credit yielding close to 6% in the US
104. 3:34and over 4% in Europe. Spreads have
105. 3:37widened, and there's no central bank
106. 3:38intervention to distort this.
107. 3:41The AI boom is resulting in record
108. 3:43levels of highly rated bond supply in a
109. 3:45new sector, often at a significant
110. 3:48discount for the rating.
111. 3:50And all of this, and more, is driving
112. 3:52significant dispersion.
113. 3:54Granted, like the Monkey's Paw, the
114. 3:56reality of this wish may feel different
115. 3:58from what investors imagined.
116. 4:00But unlike it, we don't think this is a
117. 4:02Halloween tale.
118. 4:04The fact that current conditions check
119. 4:06so many boxes of what investors were
120. 4:08looking for and address so many
121. 4:09underlying needs is a good, healthy
122. 4:12thing in our view.
123. 4:14The path is hardly straightforward.
124. 4:16But for now, we're less frightened of
125. 4:18this story.
126. 4:20Thank you, as always, for your time.
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130. 4:27friend or colleague about us today.
131. 4:29And, of course, happy Halloween.
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