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Weighing Fed Cut Against Jobs and Inflation Risks
On Wednesday, the Fed announced its first rate cut in nine months. While the reduction was widely expected, our Global Head of Macro Strategy Matthew Hornbach and Chief U.S. Economist Michael Gapen explain the data that markets and the Fed are watching.Read more insights from Morgan Stanley.----- Transcript ----- Matthew 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.Matthew Hornbach: Our topic today is the Fed's first quarter percent rate cut in 2025. We're here to discuss the implications and the path forward. It's Thursday, September 18th at 10am in New York. So, Mike, the Fed concluded its meeting on Wednesday. What was the high-level takeaway from your perspective?Michael Gapen: So, I think there's two main points here. There's certainly more that we can discuss, but two main takeaways for me are obviously the Fed is moving because it sees downside risk in the labor market.So, the August employment data revealed that the hiring rate took a large step down and stayed down, right. And the Fed is saying – it's a curious balance in the labor market. We're not quite sure how to assess it, but when employment growth slows this much, we think we need to take notice.So, they're adjusting their view. We'll call it risk management 'cause that's what Powell said. And saying there's more risk of worse outcomes in the labor market, keeping a restricted policy stance is inappropriate, we should cut. So that's part one. I think he previewed all of that in Jackson Hole. So, it was largely the same, but it's important to know why the Fed's cutting. The second thing that was interesting to me is as much as he, Powell in this case, tried to avoid the idea that we're on a preset path. That, you know, policy is always data dependent and it's always the meeting-to-meeting decision – we know that. But it does feel like if you're recalibrating your policy stance because you see more downside risk to the labor market, they're not prepared to just do once and go, ‘Well, maybe; maybe we'll go again; maybe we won't.’ The dot plots clearly indicate a series of moves here. And when pressed on, well, what's a 25 basis point rate cut going to do to help the labor market, Powell responded by, well, nothing. 25 basis points won't really affect the macro outcome, but it's the path that that matters. So, I do think; and I use the word recalibration; Powell didn't want to use that. I do think we're in for a series of cuts here. The median dot would say three, but maybe two; two to three, 75 basis points by year end. And then we'll see how the world evolves. Matthew Hornbach: So, speaking of the summary of economic projections, what struck you as being interesting about the set of projections that we got on Wednesday? And how does the Fed's idea of the path into 2026 differ from yours?Michael Gapen: Yeah. Well, it was a lot about downside risk to the labor market. But what did they do? They revised up growth. They have the unemployment rate path lower in the outer years of their forecast than they did before, so they didn't revise down this year. But they revised down subsequent years, and they revised inflation higher in 2026. That may seem at odds with what they're doing with the policy rate currently.But my interpretation of that is, you know, the main point to your question is – they're more tolerant of inflation as the cost or the byproduct of needing to lower rates to support the labor market. So, if this all works, the outlook is a little stronger from the Fed's perspective. And so, what's key to me is that they are… You know, the median of the forecast, to the extent that they align in a coherent message, are saying, we're going to have to pay a price for this in the form of stronger inflation next year to support the labor market this year. So that means in their forecast – cuts this year, but fewer cuts in 2026 and [20]27. And how that differs from our forecast is we're not quite as optimistic on the Fed, as the Fed is on the economy. We do think the labor market weakens a little bit further into 2026. So, you get four consecutive rate cuts upfront, again, inclusive of the one we got on Wednesday. And then you get two additional cuts by the middle of 2026. So, we're not quite as optimistic. We think the labor market's a little softer. And we think the Fed will have to get closer to neutral, right? Powell said we're moving “in the direction of neutral.” So, he's not committing to go all the way to neutral. And we're just saying we think the Fed ultimately will have to do that, although they're not prepared to communicate that now.Matthew Hornbach: One of the things that struck me as interesting about the summary of economic projections was the unemployment rate projection for the end of this year. So, the way that the Fed delivers these projections is they give you a number on the unemployment rate that represents the average unemployment rate in the fourth quarter of the specified year. And in this case, the median FOMC participant is projecting that the unemployment rate will average 4.5 percent. And that's what we're forecasting as well, I believe. And so, what struck me as interesting is that with an average unemployment rate of 4.5 percent in the fourth quarter of the year, which is up about 0.2 percent from today's unemployment rate of 4.3 – the Fed is only projecting one additional rate cut in 2026. And I'm curious, do you think that if we in fact get to the end of this year, and it looks like the unemployment rate has averaged about 4.5 percent – do you expect the Fed to continue to forecast only one rate cut in 2026?Michael Gapen: Yeah, I think that's… Um. The short answer is no. I think that's a challenging position to be in. And by that, I mean, in addition to that unemployment rate forecast where it's 4.5 percent for the average of the fourth quarter, which could mean December's as high as 4.6; we don't know what their monthly forecast is.But that would mean the unemployment rate's risen about a half a percentage point from its lows a few months ago. And they have inflation rising to 3 percent. Core PCE is already 2.9. So, inflation is about where it is today; [it’s] a touch firmer. But the unemployment rate has moved higher. And so, what I would say is they haven't seen a lot of evidence by December that inflation's coming back down, and the labor market has stabilized.So, this is why we think they will be more likely to get to a neutral-ish or something closer to neutral in 2026 than they're prepared to communicate now. So, I think that's a good point. So, Matt, if I could turn it back to you, I would just like first to ask you about the general market reaction. The 25 basis point cut was universally expected. So really all the potentially new news was then about the forward path from here. So how did markets reply to this? Yields did initially sell off a bit, but they generally came back. What’s your assessment of how the market took the decision?Matthew Hornbach: Yeah, so the initial five, 10 minutes after the statement and summary of economic projections is released, everybody's digesting all of the new information. And generally speaking, investors tend to see what they want to see initially in all of the materials. So initially we had yields coming down a bit, the yield curve steepened a bit. But then about half an hour later, it became clear – just right before the press conference had started; it became clear to people that actually this delivery in the documentation was a bit more moderate in terms of the forward look. That it was a fairly balanced assessment of where things are and where things may be heading.And that in the end, the Fed, while it does want to bring interest rates lower, at least in the modal case, that it is still not particularly concerned about downside risks to activity, I should say, than it is concerned about upside risks to inflation. It very much seems a balanced assessment of the risks. And I think as a result, the market balanced out its initial euphoria about lower rates with a moderation of that view. So, interest rates ended up moving slightly higher towards the end of the day. But then, the next day they came back a bit. So, I think, it was a bit more of a steady as they go assessment from markets in the end.Michael Gapen: And do you see markets as maybe changing their views on whether you know, it is a recalibration in the stance, therefore we should expect consecutive cuts? Or is the market now thinking, ‘Hey, maybe it is meeting by meeting.’ And what about the Fed’s forecast of its terminal rate versus the market's forecast of the terminal rate. So, what happened there?Matthew Hornbach: Indeed. Yeah. So, in terms of how market prices are incorporating the idea that the Fed may cut at consecutive meetings through the end of the year, I think markets are generally priced for an outcome about in line with that idea. But of course, markets, and investors who trade markets, have to take into consideration the upcoming dataset and with the Fed so data dependent; so, meeting by meeting in terms of their decisions – it could certainly be the case that the next employment report and/or the next inflation report could dissuade the committee from lowering rates again, at the end of October when the Fed next meets. So, I think the markets are, as you can expect, not going to fully price in everything that the Fed is suggesting. Both because the Fed may not end up delivering what it is suggesting; it might, or it may deliver more. So, the markets are clearly going to be data dependent as well. In terms of how the market is pricing the trough policy rate for the Fed – it does expect that the Fed will take its policy rate below where the summary of economic projections is suggesting. But that market pricing is more representative I think of a risk premium to the expectations of investors, which generally are in line or end up moving in line with the summary of economic projections over time. So, given that the Fed has changed the economic projections and the forecast for policy rates, investors probably also end up shifting a bit in terms of their own expectations. So, with that, Mike, I will bid you adieu until we speak again next time – around the time of the October FOMC meeting. So, thanks for taking the time to talk.Michael Gapen: Great speaking with you, Matt,Matthew 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.
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Special Encore: AI Takes the Wheel
Original Release Date: August 21, 2025From China’s rapid electric vehicle adoption to the rise of robotaxis, humanoids, and flying vehicles, our analysts Adam Jonas and Tim Hsiao discuss how AI is revolutionizing the global auto industry.Read more insights from Morgan Stanley.----- Transcript ----- Adam Jonas: Welcome to Thoughts on the Market. I'm Adam Jonas. I lead Morgan Stanley's Research Department's efforts on embodied AI and humanoid robots. Tim Hsiao: And I'm Tim Hsiao, Greater China Auto Analyst. Adam Jonas: Today – how the global auto industry is evolving from horsepower to brainpower with the help of AI. It's Thursday, August 21st at 9am in New York. Tim Hsiao: And 9pm in Hong Kong. Adam Jonas: From Detroit to Stuttgart to Shanghai, automakers are making big investments in AI. In fact, AI is the engine behind what we think will be a $200 billion self-driving vehicle market by 2030. Tim, you believe that nearly 30 percent of vehicles sold globally by 2030 will be equipped with Level 2+ smart driving features that can control steering, acceleration, braking, and even some hands-off driving. We expect China to account for 60 percent of these vehicles by 2030. What's driving this rapid adoption in China and how does it compare to the rest of the world? Tim Hsiao: China has the largest EV market globally, and the country’s EV sales are not only making up over 50 percent of the new car sales locally in China but also accounting for over 50 percent of the global EV sales. As a result, the market is experiencing intense competition. And the car makers are keen to differentiate with the technological innovation, to which smart driving serve[s] as the most effective means. This together with the AI breakthrough enables China to aggressively roll out Level 2+ urban navigation on autopilot. In the meantime, Chinese government support, and cost competitive supply chains also helps. So, we are looking for China's the adoption of Level 2+ smart driving on passenger vehicle to reach 25 percent by end of this year, and 60 percent by 2030 versus 6 percent and 17 percent for the rest of the world during the same period. Adam Jonas: How is China balancing an aggressive rollout with safety and compliance, especially as it moves towards even greater vehicle automation going forward? Tim Hsiao: Right. That's a great and a relevant question because over the years, China has made significant strides in developing a comprehensive regulatory framework for autonomous vehicles. For example, China was already implementing its strategies for innovation and the development of autonomous vehicles in 2022 and had proved several auto OEM to roll out Level 3 pilot programs in 2023. Although China has been implementing stricter requirements since early this year; for example, banning terms like autonomous driving in advertisement and requiring stricter testing, we still believe more detailed industry standard and regulatory measures will facilitate development and adoption of Level 2+ Smart driving. And this is important to prevent, you know, the bad money from driving out goods. Adam Jonas: One way people might encounter this technology is through robotaxis. Now, robotaxis are gaining traction in China's major cities, as you've been reporting. What's the outlook for Level 4 adoption and how would this reshape urban mobility? Tim Hsiao: The size of Level 4+ robotaxi fleet stays small at the moment in China, with less than 1 percent penetration rate. But we've started seeing accelerating roll out of robotaxi operation in major cities since early this year. So, by 2030, we are looking for Level 4+ robotaxis to account for 8 percent of China's total taxi and ride sharing fleet size by 2030. So, this adoption is facilitated by robust regulatory frameworks, including designated test zones and the clear safety guidance. We believe the proliferation of a Level 4 robotaxi will eventually reshape the urban mobility by meaningfully reducing transportation costs, alleviating traffic congestion through optimized routing and potentially reducing accidents. So, Adam, that's the outlook for China. But looking at the global trends beyond China, what are the biggest global revenue opportunities in your view? Is that going to be hardware, software, or something else? Adam Jonas: We are entering a new scientific era where the AI world, the software world is coming into far greater mental contact, and physical contact, with the hardware world and the physical world of manufacturing. And it's being driven by corporate rivalry amongst not just the terra cap, you know, super large cap companies, but also between public and private companies and competition. And then it's being also fueled by geopolitical rivalry and social issues as well, on a global scale. So, we're actually creating an entirely new species. This robotic species that yes, is expressed in many ways on our roads in China and globally – but it's just the beginning. In terms of whether it's hardware, software, or something else – it’s all the above. What we've done with a across 40 sectors at Morgan Stanley is to divide the robot, whether it flies, drives, walks, crawls, whatever – we divide it into the brain and the body. And the brain can be divided into sensors and memory and compute and foundational models and simulation. The body can be broken up into actuators, the kind of motor neuron capability, the connective tissue, the batteries. And then there's integrators, that kind of do it all – the hardware, the software, the integration, the training, the data, the compute, the energy, the infrastructure. And so, what's so exciting about this opportunity for our clients is there's no one way to do it. There's no one region to do it. So, stick with us folks. There's a lot of – not just revenue opportunities – but alpha-generating opportunities as well. Tim Hsiao: We are seeing OEMs pivot from cars to humanoids and the electric vertical takeoff in the landing vehicles or EVOTL. Our listeners may have seen videos of these vehicles, which are like helicopters and are designed for urban air mobility. How realistic is this transition and what's the timeline for commercialization in your view? Adam Jonas: Anything that can be electrified will be electrified. Anything that can be automated will be automated. And the advancement of the state of the art in robotaxis and Level 2, Level 3, Level 4+ autonomy is directly transferrable to aviation. There's obviously different regulatory and safety aspects of aviation, the air traffic control and the FAA and the equivalent regulatory bodies in Europe and in China that we will have to navigate, pun intended. But we will get there. We will get there ultimately because taking these technologies of automation and electronic and software defined technology into the low altitude economy will be a superior experience and a vastly cheaper experience. Point to point, on a per person, per passenger, per ton, per mile basis. So the Wright brothers can finally get excited that their invention from 1903, quite a long time ago, could finally, really change how humans live and move around the surface of the earth; even beyond, few tens of thousands of commercial and private aircraft that exist today. Tim Hsiao: The other key questions or key focus for investors is about the business model. So, until now, the auto industry has centered on the car ownership model. But with this new technology, we've been hearing a new model, as you just mentioned, the shared mobility and the autonomous driving fleet. Experts say it could be major disruptor in this sector. So, what's your take on how this will evolve in developed and emerging markets? Adam Jonas: Well, we think when you take autonomous and shared and electric mobility all the way – that transportation starts to resemble a utility like electricity or water or telecom; where the incremental mile traveled is maybe not quite free, but very, very, very low cost. Maybe only; the marginal cost of the mile traveled may only just be the energy required to deliver that mile, whether it's a renewable or non-renewable energy source. And the relationship with a car will change a lot. Individual vehicle ownership may go the way of horse ownership. There will be some, but it'll be seen as a nostalgic privilege, if you will, to own our own car. Others would say, I don't want to own my own car. This is crazy. Why would anyone want to do that? So, it's going to really transform the business model. It will, I think, change the structure of the industry in terms of the number of participants and what they do. Not everybody will win. Some of the existing players can win. But they might have to make some uncomfortable trade-offs for survival. And for others, the car – let’s say terrestrial vehicle modality may just be a small part of a broader robotics and then physical embodiment of AI that they're propagating; where auto will just be a really, really just one tendril of many, many dozens of different tendrils. So again, it's beginning now. This process will take decades to play out. But investors with even, you know, two-to-three or three-to-five-year view can take steps today to adjust their portfolios and position themselves. Tim Hsiao: The other key focus of the investor over the market would definitely be the geopolitical dynamics. So, Morgan Stanley expects to see a lot of what you call coopetition between global OEMs and the Chinese suppliers. What do you mean by coopetition and how do you see this dynamic playing out, especially in terms of the tech deflation? Adam Jonas: In order to reduce the United States dependency on China, we need to work with China. So, there's the irony here. Look, in my former life of being an auto analyst, every auto CEO I speak to does not believe that tariffs will limit Chinese involvement in the global auto industry, including onshore in the United States. Many are actively seeking to work with the Chinese through various structures to give them an on-ramp to move onshore to produce their, in many cases, superior products, but in U.S. factories on U.S. shores with American workers. That might lead to some, again, trade-offs. But our view within Morgan Stanley and working with you is we do think that there are on-ramps for Chinese hardware, Chinese knowhow, and Chinese electrical vehicle architecture, but while still being sensitive to the dual-purpose AI sensitivities around software and the AI networks that, for national security reasons, nations want to have more control over. And I actually am hopeful and seeing some signs already that that's going to happen and play out over the next six to 12 months. Tim Hsiao: I would say it's clear that the road ahead isn't just smarter; it’s faster, more connected, and increasingly autonomous. Adam Jonas: That's correct, Tim. I could not agree more. Thanks for joining me on the show today. Tim Hsiao: Thanks, Adam. Always a pleasure. Adam Jonas: And to our listeners, thanks for listening. Until next time, stay human and keep driving forward. 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.
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How U.S. Industry Is Reinventing Itself
Our strategists Michelle Weaver and Adam Jonas join analyst Christopher Snyder to discuss the most important themes that emerged from the Morgan Stanley Annual Industrials Conference in Laguna Beach.Read more insights from Morgan Stanley.----- Transcript ----- Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley's U.S. Thematic Strategist.Christopher Snyder: I'm Chris Snyder, Morgan Stanley's U.S. Multi-Industry Analyst.Adam Jonas: And I'm Adam Jonas, Morgan Stanley's Embodied AI Strategist.Michelle Weaver: We recently concluded Morgan Stanley's annual industrials conference in Laguna Beach, California, and wanted to share some of the biggest takeaways.It's Tuesday, September 16th at 10am in New York.I want to set the stage for our conversation. The overall tone at the conference was fairly similar to last year with many companies waiting for a broader pickup. And I'd flag three different themes that really emerged from the conference.So first, AI. AI is incredibly important. It appeared in the vast majority of fireside conversations. And companies were talking about AI from both the adopter and the enabler angle.Second theme on the macro, overall companies remain in search of a reacceleration. They pointed to consistently expansionary PMIs or a PMI above 50, a more favorable interest rate environment and greater clarity on tariffs as the key macro conditions for renewed momentum.And then the last thing that came up repeatedly was how are companies going to react to tariffs? And I would say companies overall were fairly constructive on their ability to mitigate the margin impact of tariffs with many talking about both leveraging pricing power and supply chain shifts to offset those impacts. So, Chris, considering all this, the wait for an inflection came up across a number of companies. What were some of your key takeaways on multis, on the macro front?Christopher Snyder: The commentary was stable to modestly improving, and that was really consistent across all of these companies. There are, you know, specific verticals where things are getting better. I would call out data center as one. Non-res construction, as another one, implant manufacturing as one. And there were certain categories where we are seeing deterioration – residential HVAC, energy markets, and agriculture.But we came away more constructive on the cycle because things are stable, if not modestly improving into a rate cut cycle. The concern going in was that we would hear about deteriorating trends and a rate cut would be needed just to stabilize the market. So, we do think that this backdrop is supportive for better industrial growth into 2026.We have been positive on the project or CapEx side of the house. It feels like strength there is improving. We've been more cautious on the short cycle production side of the house. But we are starting to see signs of rate of change. So, when we look into [20]26 and [20]27, we think U.S. industrials are poised for decade high growth.Michelle Weaver: You've had a thesis for a while now that U.S. reshoring is going to be incredibly important and that it's a $10 trillion opportunity. Can you unpack that number? What are some recent data points supporting that and what did you learn at the conference? Christopher Snyder: Some of the recent data points that support this view is U.S. manufacturing construction starts are up 3x post Liberation Day. So, we're seeing companies invest. This is also coming through in commercial industrial lending data, which continues to push higher almost every week and is currently at now record high levels. So, there's a lot of reasons for companies not to invest right now. There's a lot of uncertainty around policy. But seeing that willingness to invest through all of the uncertainty is a big positive because as that uncertainty lifts, we think more projects will come off the sidelines and be unlocked. So, we see positive rate of change on that. What I think is often lost in the reassuring conversation is that this has been happening for the last five years. The U.S. lost share of global CapEx from 2000 when China entered the World Trade Organization almost every year till 2019 when Trump implemented his first wave of tariffs. Since then, the U.S. has taken about 300 basis points of global CapEx share over the last five years, and that's a lot on a $30 trillion CapEx base. So, I think the debate here should be: Can this continue? And when I look at Trump policy, both the tariffs making imports more expensive, but also the incentives lowering the cost of domestic production – we do think these trends are stable.And I always want to stress that this is a game of increments. It's not that the U.S. is going to get every factory. But we simply believe the U.S. is better positioned to get the incremental factory over the next 20 years relative to the prior 20. And the best point is that the baseline growth here is effectively zero.Michelle Weaver: And how does power play into the reshoring story? AI and data centers are generating huge demand for power that well outstrip supply. Is there a risk that companies that want to reshore are not able to do so because of the power constraints?Christopher Snyder: It's a great question. I think it's part of the reason that this is moving more slowly. The companies that sell this power equipment tend to prioritize the data center customers given their scale in magnitude of buying. But ultimately, we think this is coming and it's a big opportunity for U.S. power to extend the upcycle.Manufacturing accounts for 26 percent of the electricity in the country. Data center accounts for about 5 percent. So, if the industrial economy returns to growth, there will be a huge pull on the grid; and I view it as a competitive advantage. If you think about the future of U.S. manufacturing, we're simply taking labor out and replacing it with electricity. That is a phenomenal trade off for the U.S. And a not as positive trade off for a lot of low-cost regions who essentially export labor to the world.I'm sure Adam will have more to say about that.Michelle Weaver: And Adam, I want to bring robotics and humanoid specifically into this conversation as the U.S.' technological edge is a big part of the reshoring story. So how do humanoids fit into reshoring? How much would they cost to use and how could they make American manufacturing more attractive?Adam Jonas: Humanoid robots – we're talking age agentic robots that make decisions from themselves autonomously due to the dual purpose in the military. You know, dual purpose aspect of it makes it absolutely necessary to onshore the technologies.At the same time, humanoid robots actually make it possible to onshore those technologies. Meaning you need; we're not going to be able to replicate manufacturing and onshore manufacturing the way it's currently done in China with their environmental practices and their labor – availability of affordable cheap human labor.Autonomous robots are both the cause of onshoring. And the effect of onshoring at the same time, and it's going to transform every industry. The question isn't so much as which industry will autonomous robots, including humanoids impact? It's what will it not.And we have not yet been able to find anything that it would. When you think about cost to use – we think by 2040 we get to a point where to Chris's point, the marginal cost of work will be some factor of electricity, energy, and some depreciation of that physical plant, or the physical robot itself.And we come up with a, a range of scenarios where centered on around $5 per hour. If that can replace two human workers at $25 an hour, that can NPV to around $200,000 of NPV per humanoid. That's discounting back 15 years from 2040.Michelle, there's 160 million people in the U.S. labor market, so if you just substituted 1 percent of that or 1.6 million people out of the U.S. Labor pool. 1.6 million times $200,000 NPV; that's $320 billion of value, which is worth, well, quite a lot. Quite a lot of money to a lot of companies that are working on this.So, when we get asked, what are we watching, well, in terms of the bleeding edge of the robot revolution, we're watching the Sino-U.S. competition. And I prefer to call it competition. And we're also watching the terra cap companies, the Mag 7 type companies that are quite suddenly and recently and very, very significantly going after physical AI and robotics talent. And increasingly even manufacturing talent.So again, to circle back to Chris's point, if you want evidence of reshoring and manufacturing and advanced manufacturing in this country, look at some of these TMT and tech and AI companies in California. And look at, go on their hiring website and watch all the manufacturing and robotics people that they're trying to hire; and pay a lot of money to do so. And that might be an interesting indicator of where we're going.Michelle Weaver: I want to dig in a little bit more there. We're seeing a lot of the cutting-edge tech coming out of China. Is the U.S. going to be able to catch up?Adam Jonas: Uh, I don't know. I don't know. But I would say what's our alternative. We either catch up enough to compete or we're up for grabs. OK?I would say from our reading and working closely with our team in China, that in many aspects of supply chain, manufacturing, physical AI, China is ahead. And with the passage of time, they are increasingly ahead. We estimate, and we can't be precise here, that China's lead on the U.S. would not only last three to five years, but might even widen three to five years from now. May even widen at an accelerating rate three to five years from now.And so, it brings into play is what kind of environment and what kind of regulatory, and policy decisions we made to help kind of level the playing field and encourage the right kind of manufacturing. We don't want to encourage trailing edge, Victorian era manufacturing in the U.S. We want to encourage, you know, to skate to where the puck is going technology that can help improve our world and create a sustainable abundance rather than an unsustainable one. And so, we're watching China very, very closely.It makes us a little bit; makes me a little bit kind of nervous when we – if we see the government put the thumb on the scale too much.But it's invariably going to happen. You're going to have increased involvement of whichever administration it is in order to kind of set policies that can encourage innovation, education of our young people, repurposing of labor, you know. All these people making machines in this country now. They might get, there may be a displacement over a number of years, if not a generation.But we need those human bodies to do other things in this economy as well. So, we; I don't want to give the impression at all in our scenarios that we don't need people anymore.Michelle Weaver: What are the opportunities and the risks that you see for investors as robotics converges with this broader U.S. manufacturing story?Adam Jonas: Well, Michelle, we see both opportunities and risks. There are the opportunities that you can measure in terms of what portion of global GDP of [$]115 trillion could you look at. I mean, labor alone is $40 trillion.And if you really make humanoid that can do the work of two workers, guess what? You're not going to stop at [$]40 trillion. You're going to go beyond that. You might go multiple beyond that. Talking about the world before AI, robotics and humanoid is like talking about the world before electricity. Or talking about business before the internet. We don't think we're exaggerating, but the proof will be in the capital formation. And that's where we hope we can be of assistance to our clients working together on a variety of investment ideas. But the risks will come and it is our professional responsibility, if not our moral responsibility, to work with our partners across research to talk about those risks. Michelle, if we have labor displacement, go too quickly, there’s serious problems. And if you don't, if you don't believe me, go look at, look at you know, the French Revolution or the Industrial Revolution, or Age of Enlightenments. Ages of scientific enlightenment frequently cohabitate times of great social and political turmoil as well. And so, we think that these risks must be seen in parallel if we want to bring forth technologies that can make us more human rather than less human.I'm sorry if I'm coming across as a little preachy, but if you studied robots and labor all day long, it does have that effect on you.So, Michelle, how do you see innovation priorities changing for industrials and investors in this environment?Michelle Weaver: I think it's huge as we're seeing AI and technology broadly diffuse across different segments of the market, it's only becoming more important. About two-thirds of companies at the conference mentioned AI in some way, shape, or form. We know that from transcripts. And we're seeing them continue to integrate AI into their businesses. They're trying to go beyond what we've just seen at the initial edge.So, for example, if I think about what was going on within AI adoption a couple years ago, it was largely adding a chat bot to your website that's then able to handle a lot of customer service inquiries. Maybe you could reduce the labor there a little bit.Now we're starting to see a lot more business specific use cases. So, for example, with an airline, an airline company is using AI to most optimally gate different planes as they're landing to try and reduce connection times. They know which staff needs to go to another flight to connect, which passengers need to move to another flight. They're able to do that much more efficiently.You're seeing a lot on AI being adopted within manufacturing to make manufacturing processes a lot more seamless. So, I think innovation is only going to continue to become more important to not only industrials, but broadly the entire market as well.Clearly the industry is being shaped by adaptability, collaboration, and a focus on innovation. So, Chris, Adam, thank you both for taking the time to talk.Adam Jonas: Always a pleasure. Michelle.Christopher Snyder: Thank you for having us on.Michelle Weaver: 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.
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Can Fed Cuts Bring Mortgage Rates Down?
For investors looking to make sense of housing-related assets amidst changes in Fed policy stance, our co-heads of Securitized Product Research Jay Bacow and James Egan offer their perspective on mortgage rates and the market.Read more insights from Morgan Stanley.----- Transcript ----- James Egan: Welcome to Thoughts on the Market. I'm Jim Egan, co-head of Securitized Products Research at Morgan Stanley.Jay Bacow: I'm Jay Bacow, the other co-head of Securitized Products Research at Morgan Stanley.Today we're talking about the Fed, mortgage rates and the implications to the housing market.It's Monday, September 15th at 11:30am in New York.Now Jim, the Fed is meeting on Wednesday, and both our economists and the market are expecting them to cut rates in this meeting – and continue to cut rates at least probably two more times in 2025, and multiple times in 2026. We've talked a lot about the challenges and the affordability in the U.S. homeowners’ market, in the U.S. mortgage market.Before we get into what this could help [with] the affordability challenges, how bad is that affordability right now?James Egan: Sure. And as we've discussed on this podcast in the past, one of the biggest issues with the affordability challenges in the U.S. housing market specifically is how it's fed through to supply issues as the lock-in effect has kept homeowners with low 30-year mortgage rates from listing their homes.But just how locked in does the market remain today? The effective rate on the outstanding mortgage market, kind of the average of the mortgages outstanding, is below 4.25 percent. The prevailing rate for 30-year mortgages today is still over 6.25 percent, so we're talking about two full percentage points, 200 basis points outta the money.Jay Bacow: And that seems like a lot. Has it been that way in the past?James Egan: If we look at roughly 40 years of data ending in 2022, the market was only 100 basis points outta the money for eight individual quarters. The most it was ever out of the money was 135 basis points. We have now been more than 200 basis points out of the the money for three entire years, 12 consecutive quarters. So, this is very unprecedented in the past several decades.But Jay, our economists are calling for Fed cuts, the market's pricing in Fed cuts. How much lower is the mortgage rate going for these affordability equations?Jay Bacow: We actually don't think that the Fed cutting rates necessarily is going to cause the mortgage rate to come down at all. And one way we can think about this is if we look at it, the Fed has already cut rates 100 basis points over the past year, and since the Fed has cut rates 100 basis points in the past year, the mortgage rate is 25 basis points higher.James Egan: Okay, so if I'm not going to be looking at Fed funds for the path of mortgage rates going forward, I have two questions for you.One, what part of the Treasury term structure should I be looking at? And two, you talked about the market pricing in Fed cuts from here. What is the market saying about where those rates will be in the future?Jay Bacow: So, mortgage rates are much more sensitive to the belly of the Treasury curve. Call it the 5- and 10-year portions than Fed funds. They have a little bit of sensitivity to the third year note as well. And when we think about what the market is expecting those portions of the Treasury curve to do, I apologize, I'm going to have to nerd out. Fortunately, being a nerd comes very naturally to me.If you look at the spread between the 5- and the 10-year portion of the treasury curve, 10 years yield about 50 basis points more than the 5-year note. So, you think about it, an investor could buy a 10-year note now. Or they could buy a 5-year note now and then another 5-year note in five years, and they should expect to get the same return if they do either one.So, if they buy the 10-year note right now at 50 basis points above where the 5-year note is. Or they buy the 5-year note, right now, the 5-year note in five years would have to yield 100 basis points above to get the average to be the same. Well, if the 5-year note in five years is 100 basis points above where the 5-year note is right now, mortgage rates are also probably going to be higher in five years.James Egan: Okay, so that's not helping the affordability issues. What can be done to lower mortgage rates from here?Jay Bacow: Well, going back to my inner nerd, if you brought the 5- and 10-year Treasury yields down, that would certainly be helpful. But mortgage rates aren't just predicated on where the Treasury yields are.There's also a risk premium on top of that. And so, if the mortgage originators can sell those loans to other investors at a tighter spread, that would also help bring the rate down. And there are things that can be done on that front. So, for instance, if the capital requirements for investors to own those mortgages go down, that would certainly be helpful.You could try to incentivize investors in a number of different ways, that's one front. But in reality, a lot of these fees are already sort of stuck in place. So, there's only so much that can be done.Now, Jim, let's suppose. I am wrong. I've been wrong in the past. A lot of times with you. I thought the Patriots were gonna beat the Giants in both Super Bowls. Somehow Eli Manning proved me wrong.However, if the mortgage rate does come down, how much does it have to come down for housing activity to start picking up?James Egan: So, this is a question we get asked roughly six to seven times a day…Jay Bacow: How did Eli Manning beat the Patriots?James Egan: How far mortgage rates have to come down in order to really get housing sales started again. And because of the backdrop of today's housing and mortgage markets that we laid out at the top of this podcast, it's really difficult to empirically point to a mortgage rate and calculate this is where rates have to fall to.So, what we have been doing instead is looking at historic periods of affordability improvement, and seeing how much do we need to get that affordability ratio down to get a sustainable growth in sales volumes from here.Jay Bacow: All right. And how much do we have to get that affordability ratio down?James Egan: So, a sustainable increase; historically, we've needed about a 10 percent improvement in the affordability ratio…Jay Bacow: Alright, help me out here. I think about mortgage payments as more of a function of the rate level. So, if we're in the context of like 6.25, 6.5 right now, how far does the mortgage rate need to drop to get a 10 percent improvement? Assuming that there's no change in borrower's income or home prices.James Egan: In that world, we think you need about 100 basis point move. It would take the 30-year mortgage rate to call it, 5.5 percent.Jay Bacow: All right, so if mortgage rates go to 5.5 percent, then we're going to immediately see housing activity pickup.James Egan: That is not exactly what we're saying. What we've seen is the 10 percent improvement is enough to get sustainable growth in sales volumes. A year after you start to see that real improvement, the contemporaneous moves can be up, they can be down. Given what our economists are saying for the labor market going forward, what they're saying for growth in the United States, we do think you can see a little bit of contemporaneous growth.If you start to see that 100 basis point move in mortgage rates now, we think you'll get about a 5 percent increase in purchase volumes as we move through 2026 with the potential for upward inflection in 2027 from that 5 percent growth number – again, if we get that move in mortgage rates.Jay Bacow: Alright, so we expect the Fed to cut rates about 150 basis points over the next year and a half. It doesn't necessarily have to bring the mortgage rate down. But if the mortgage rate does go down to in the context of 5.5 percent, we should start to get a pickup in housing activity maybe the year after that.Jim, always a pleasure talking to you.James Egan: Pleasure talking to you too, Jay. And to all of you regularly hearing us out, thank you for listening to another episode of Thoughts on the Market.Jay Bacow: Please leave us a review or a like wherever you get this podcast and share your Thoughts on the Market with a friend or colleague today.James Egan: Go smash that subscribe button.
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How Cybersecurity Is Reshaping Portfolios
Online crime is accelerating, making cybersecurity a fast-growing and resilient investment opportunity. Our Cybersecurity and Network and Equipment analyst Meta Marshall discusses the key trends driving this market shift.Read more insights from Morgan Stanley.----- Transcript ----- Welcome to Thoughts on the Market. I’m Meta Marshall, Morgan Stanley’s Cybersecurity and Network and Equipment Analyst. Today – the future of digital defense against cybercrime. It’s Friday, September 12th, at 10am in New York.Imagine waking up to find your bank account drained, your business operations frozen, or your personal data exposed – all because of a cyberattack. Today, cybersecurity isn't an esoteric tech issue. It impacts all of us, both as consumers and investors. As the digital landscape grows increasingly complex, the scale and severity of cybercrime expand in tandem. This means that even as companies spend more, the risks are multiplying even faster. For investors, this is both a warning and an opportunity.Cybersecurity is now a $270 billion market. And we expect it to grow at 12 percent per year through 2028. That's one of the fastest growth rates across software. And here's another number worth noting: Chief Information Officers we surveyed expect cybersecurity spending to grow 50 percent faster than software spending as a whole. This makes cybersecurity the most defensive area of IT budgets—meaning it’s least likely to be cut, even in tough times.This hasn’t been lost on investors. Security software has outperformed the broader market, and over the past three years, security stocks have delivered a 58 percent return, compared to just 22 percent for software overall and 79 percent for the NASDAQ. We expect this outperformance against software to continue as AI expands the number of ways hackers can get in and the ways those threats are evolving.Looking ahead, we see a handful of interconnected mega themes driving investment opportunities in cybersecurity. One of the biggest is platformization – consolidating security tools into a unified platform. Today, major companies juggle on average 130 different cyber security tools. This approach often creates complexity, not clarity, and can leave dangerous gaps in protection particularly as the rise of connected devices like robots and drones is making unified security platforms more important than ever.And something else to keep in mind: right now, security investments make up only 1 percent of overall AI spending, compared to 6 percent of total IT budgets—so there’s a lot of room to grow as AI becomes ever more central to business operations. In today’s cybersecurity race, it’s not enough to simply pile on more tools or chase the latest buzzwords. We think some of the biggest potential winners are cybersecurity providers who can turn chaos into clarity. In addition to growing revenue and free cash flow, these businesses are weaving together fragmented defenses into unified, easy-to-manage platforms. They want to get smarter, faster, and more resilient – not just bigger. They understand that it’s key to cut through the noise, make systems work seamlessly together, and adapt on a dime as new threats emerge. In cybersecurity, complexity is the enemy—and simplicity is the new superpower. 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.
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