Thoughts on the Market

The UK budget arrives later this month amid competing predictions about growth, inflation and public finances. Andrew Sheets and Bruna Skarica examine how the country’s economy defies expectations.
Read more insights from Morgan Stanley.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.
Bruna Skarica: And I'm Bruna Skarica, Morgan Stanley's Chief UK Economist.
Andrew Sheets: Today, the UK makes a budget. Why it matters? And more generally, what we've gotten right and wrong about the country.
It's Wednesday, October 14th, at 2pm in London.
Bruna, it's great to be here talking with you, and I'd like to get into a bigger discussion on the UK and what we've gotten right and wrong about the direction of the country this year. But more immediately, it has a very big event coming up.
What is the budget, and why is there so much focus on it?
Bruna Skarica: The budget is the UK's key fiscal event. It is the time of year when the Chancellor receives a refresh of economic forecasts and decides whether he needs to respond to these, whether there's any spending cuts or increases that are required, and whether there's any tax hikes or potentially tax cuts that are required too. All with the view of ensuring fiscal consolidation and executing on what is a self-imposed fiscal framework.
Here in the UK, the main target for the Treasury is to achieve current budget balance in year three of the forecast. The fiscal watchdog forecasts five years of economic variables, and the idea is, by the third year, we ought to be spending outside of investment expenditure as much as we're receiving in tax receipts.
So, all of that happens once a year in the budget.
Andrew Sheets: Now, I might just stop you there [be]cause in the context of these other budget pictures that we see around the world – the U.S. is running a large budget deficit, France is running a large budget deficit, Japan's increasing its budget deficit. That actually seems like a quite ambitious goal within the next three years; to balance that outside of the interest expenses.
Can you just talk maybe a little bit more about that process and the thinking behind it?
Bruna Skarica: Yeah, sure. The idea really is to ensure that over the next five years, not only do we get the current budget balanced while allowing for borrowing for investment, which is, of course, a favorable way to borrow because it boosts growth.
But also, that within the five-year period, we're able to get debt-to-GDP ratio down. In order for that to happen, we need to be running a primary surplus around 1.5 percent of GDP.
Now, very often in UK macro, we tend to look at three-year forecasts, five-year forecasts. We talk about medium-term headrooms. But I think it's important here to take stock of where we are at this moment in time.
We think that in this fiscal year, [20]26-[20]27, primary deficit – our entire expenditure outside debt servicing costs minus tax receipts – we see that at just under 1 percent of GDP. The IMF is a little bit above 1 percent of GDP for UK. But for example, the IMF sees French primary deficit at 2.9 percent this year, with the U.S. measure forecast at 4.9 percent.
So already, UK has actually made a lot of progress in its consolidation path.
Andrew Sheets: And Bruna, talking about this announcement specifically, could you maybe talk about just one or two items that you'd be on the watch for as potential surprises? Or decisions that the market is really focused on?
Bruna Skarica: Sure. So, we do know that the Treasury is looking at ways of alleviating some of the pressures stemming from higher inflation, higher energy inflation in particular. So, the scale of support that will be provided to households and the scale of reduction in headline inflation, I do think will be in focus on the day.
We're expecting a relatively low-key budget, so the scale of measures at around £10 billion, which is much more moderate than what we saw in October 2024 and in November 2025.
However, we do think there is scope for some, let's say, higher level announcements. For example, Prime Minister Burnham is particularly focused on devolution in the UK, decentralization. And there might be a roadmap ahead for how different mayors and different regions in the UK get to keep their portion of income tax revenues and what they might do with it in order to boost regional growth.
UK does stand out as the country in G7 space that has the most centralized fiscal system, and this might start to be changed from this fiscal event onwards.
Andrew Sheets: Okay, so now I'd like to take a step back and do a little marking to market.
You know, you and I on this program, a couple of different times this year, have been talking about the UK, and those conversations have generally been upbeat. I think both of us were of the view that the UK could actually be a bit better of a story than expected. And maybe we start with the good news.
What do you think has been going right?
Bruna Skarica: So, for one, growth has outperformed in the first half of the year. In line with our long-standing thesis that UK ought to be a beneficiary of the global AI boom, the main driver of the upside surprise has been the tech sector. It's running at 8 percent year-on-year, this year.
We have also seen a bit stronger consumer spending growth than anticipated. And again, this reflects, we think, our long-standing thesis on fairly clean household. But also corporate balance sheets, I should mention, that tend to provide a fairly big buffer in one of energy shocks.
UK consumers have elevated savings, also elevated savings stocks, and so in energy shocks such as the one we've seen in the first half of the year, perhaps there is some reduction in desired level of savings, which allows consumers to support their spending habits.
All of this means that this year we see UK growth at 1.3 percent. Now, our U.S. colleagues are looking for 2.3 percent. Still, U.S. growth looks relatively stronger than any European country, including the UK.
However, I would say that 1.3 percent is about 30 basis points higher than where we were a couple of months ago when the energy shock started, so it is important to take that into account.
Andrew Sheets: And I'd also note that UK stocks are up about 10 percent this year, and its currency, the pound, is materially outperformed the euro or the Japanese yen.
But Bruna, I think it's pretty safe to say that sentiment towards the UK feels pretty downbeat. I think it's probably gotten worse as the year has gone on.
So, what's gone wrong and what's been worse than we were expecting?
Bruna Skarica: Yeah. So, while I do think that in the U.S. there is a lot of focus on the benefits from the AI boom and the AI build-out, in Europe, we're still waiting to see the sentiment shift towards how much growth and potential growth in particular can benefit from adopting AI.
We're more constructive, I would say, than probably the average forecaster here. We're pointing to healthy productivity growth performance in the UK private sector, printing productivity growth at 1.8 percent; whereas in the U.S. this figure is a bit above 2 percent over the second quarter this year. So, not too different, I would say.
So, I think the pessimism around potential GDP growth is really what's driving the view that whenever an external energy shock tends to hit, such as the one we've seen this year with higher oil and natural gas prices, it'll be embedded in the economy for a longer period of time. Because ultimately a spare capacity is very tight. And so businesses and consumers will try and preserve their real purchasing power, and inflation will remain elevated for a longer period of time.
Again, we tend to be a bit more constructive on this. We think the economy has enough spare capacity for this energy shock to come and go without material adjustments in the bank rate. We're expecting two hikes. But the market is still pricing four hikes. And certainly in conversations with investors, we are more and more talking about the scenarios in which these could be delivered.
So that, of course, means higher gilt yields, which means higher debt servicing costs, and that overall, I do think tends to dampen sentiment.
Andrew Sheets: Well, Bruna, a lot to watch in the days and weeks ahead. And thank you so much for taking the time.
Bruna Skarica: Thank you, Andrew.
Andrew Sheets: And thank you as always for listening. If you find Thoughts on the Market useful, let us know by leaving a review wherever you hear us. And also tell a friend or colleague about us today.

Our Head of Asia Credit Strategy Kelvin Pang explains why investors would benefit from a broader fixed income market in Asia, with opportunities across more countries, local-currency credit and dollar-denominated bonds.
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Welcome to Thoughts on the Market. I’m Kelvin Pang, Head of Asia Credit Strategy [at] Morgan Stanley.
Today – why the challenge in Asia fixed income may not be the region at all, but the way investors have traditionally looked at it.
It’s Tuesday, October 13th at 8am in Hong Kong.
Picture this. You’re shopping in a supermarket. As you walk down the aisles, you notice half of them are off limits. It’s unexpected.
Something similar has happened in Asia fixed income. The region’s fundamentals remain supportive, but the traditional investment universe has become increasingly constrained.
The pressure began in early 2023, when U.S. policy rates rose above those in much of Asia for the first time since before the Global Financial Crisis. The environment that had supported Asian bond markets for years turned upside down.
Consider Asia-dollar credit. Issuers have increasingly turned to cheaper local-currency financing, which is shrinking dollar-bond supply. Asia-dollar credit is now on track for a fifth straight year of negative net supply. At the same time, investment-grade spreads have tightened to 55 basis points. That makes Asia investment-grade credit the most tightly valued major credit market globally.
And investors have taken notice of this. Assets in dedicated Asia credit and high-yield funds have fallen 62 percent from their 2021 peak – from roughly $75 billion USD to around $29 billion USD.
But we feel Asia itself is not the problem. In fact, Asia Pacific nominal GDP could rise from $41 trillion USD in 2025 to [$]54 trillion by 2031. That would account [for] roughly one-third of global nominal GDP growth over that period.
And most importantly investment is also accelerating. Asia’s capital spending could rise from $11 trillion to [$]16 trillion by 2030. That would mark the strongest industrial cycle since the mid-2000s. And we think this extends well beyond AI, with energy, defense, and broader industrial investment all playing major roles.
The key issue here is how investors have traditionally looked at Asia. They basically need a bigger map.
That broader map is what we call APAC fixed income. Traditional Asia fixed income has largely focused on U.S.-dollar credit and local-currency government bonds across emerging Asia. APAC fixed income adds convertible bonds and local-currency corporate credit. It also brings Japan and Australia into the mix.
So, what’s the advantage of this broader map? You see, each of these pieces behaves differently. Convertible bonds let investors participate in regional growth through their equity link. APAC dollar credit plays a more defensive role, with a mostly investment-grade, U.S.-dollar-denominated profile. Local-currency rates provide exposure to interest rates, currencies and the economic cycle. At the same time, local-currency corporate credit broadens credit and sector exposure.
Together, they create a more flexible mix of risks across changing economic conditions. For example, when growth and inflation rise together, convertible bonds can benefit from their equity link. In a recession, currency-hedged local bonds can benefit from falling rates while limiting foreign-exchange risk. During stagflation, dollar credit can offer more defensive characteristics.
Our portfolio analysis since 2023 suggests a diversified APAC fixed-income portfolio could target a 7.5 percent return with a vol[atility] of roughly 4 percent, depending on allocation constraints. Investors also increasingly need to manage currency exposure as the dollar cycle shifts.
For years, investors could navigate Asian bonds with a relatively narrow toolkit. Today’s market demands more flexibility. The opportunity in Asia has not disappeared. The better question may be whether investors are looking at enough of it.
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.

Energy costs are a key election issue and AI data centers are adding to the debate. Our Head of Public Policy Research Ariana Salvatore looks at policy discussions in Washington that could determine how the U.S. powers its next technological boom.
Read more insights from Morgan Stanley.

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of Public Policy Research at Morgan Stanley.
Today, I'll discuss the growing energy demands of AI and what the government can do in response.
It's Monday, October 12th at 10am in New York.
Markets and policymakers are preparing for a potentially important debate following the November elections. The future of American energy infrastructure. And at the center of that debate is an increasingly urgent question: How can the U.S. build enough power infrastructure to support the AI investment cycle – without passing the costs on to everyday electricity consumers?
Late last month, lawmakers in Congress introduced the bipartisan American Affordability and Jobs Act. That legislation represents a significant effort to reform federal permitting. But importantly, it also includes provisions that require data centers to cover the transmission costs associated with their projects.
We think that's a notable development, particularly as we think about the legislative agenda after the November elections. Of course, the path forward still remains uncertain given substantial policy differences and a limited legislative calendar after the elections.
But why might this matter for markets?
Well, first, it's worth considering the scale of the energy challenge. My colleague Stephen Byrd and his team recently updated their projections for the U.S. data center power shortfall. They now see a potential 57-gigawatt gap through 2028, and that's before accounting for new solutions that could accelerate access to power. That's up from their previous estimate of 38-gigawatts.
And that's why the permitting proposal is so important. There are two elements that I'd highlight.
First is the effort to accelerate infrastructure development. The bill would reform federal environmental reviews and provide greater certainty for projects that have already received approvals. We think that can help reduce delays and uncertainty around new energy projects, although permitting reform alone won't resolve constraints involving equipment, labor, or grid capacity.
The second element is the growing focus on who pays for the infrastructure, and here the proposal actually builds on an existing policy initiative. Earlier this year, a number of hyperscalers signed on to the Ratepayer Protection Pledge.
That's a voluntary agreement under which companies commit to securing the electricity needed for their data centers and pay for associated power infrastructure upgrades rather than passing the costs on to residential consumers. The pledge was subsequently expanded to include a broader group of utilities, developers, and state participants.
Now, what's different about the permitting reform bill is its potential shift from voluntary commitments toward federal requirements. In particular, the proposal would require data centers to cover their associated transmission costs.
That's an area where we think policymakers from both parties appear to share concerns about electricity affordability, even though they may disagree over the broader approach to energy policy.
Looking beyond the elections, we think that creates two related policy catalysts for investors to watch.
The first is whether Congress can reach an agreement on permitting reform that helps accelerate the construction of energy infrastructure. And second, whether lawmakers move to establish a more formal cost-sharing requirement for data centers.
The eventual policy mix, we think, could influence both the timing and the economics of new projects. Faster approvals could make some investments more attractive. But requiring developers to absorb additional transmission costs could also change where projects are built and which power solutions they pursue. A changing policy framework could also reinforce the importance of alternatives.
Of course, legislation is far from guaranteed. The elections will shape the political environment in which these negotiations continue, and any final agreement could differ substantially from the current proposal.
But stepping back, I think there's a broader takeaway.
For much of the AI investment cycle, the focus has been on the pace of technological innovation and capital spending. Increasingly, though, policy decisions around electricity infrastructure, permitting, and affordability could become just as important in determining how quickly that investment translates into operational capacity.
The permitting bill is an early indication of how D.C. may approach those challenges after the elections. And for investors, the central question may be less about how much companies are willing to spend on AI and more about how quickly and at what cost they can secure the power needed to support it.
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.

Markets have remained resilient despite the prospect of higher-for-longer rates. Our Global Head of Fixed Income Research Andrew Sheets considers the risks building beneath the surface.
Read more insights from Morgan Stanley.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.
Today, exploring further the question that seems to be on everyone's mind: At what point do higher rates become a problem for markets?
It's Friday, October 9th, at 2pm in London.
We recently hosted Morgan Stanley's ninth annual European Credit Conference here in London. Fifty companies, over a thousand investors, and to some extent, one dominating question.
The market has been impressively resilient this year – but as yields rise, at what point does this change?
I think a good place to start with this question is whether the current level of interest rates are obviously wrong. And I don't think it's clear that they are. Growth in the U.S., Europe, and Asia remains surprisingly robust and has for a lot of this year. Meanwhile, inflation across regions is still generally above central bank targets.
Too high, and a sign that conditions are more likely too hot than too cold. That's the opposite of what the wrong level of rates would imply – as rates that were too high would be curtailing activity and pushing inflation down below target.
Thanks in part to the scale of AI spending and how insensitive the spending has been to the level of interest rates; we're just not seeing this.
I think the yield curve is also confirming this message that the level of rates for now is okay. In an environment where the market thinks that central banks have raised rates too much, it will often so-call invert the yield curve. Pushing short-term interest rates above longer-term ones on the belief that rates that are too high today will need to be lowered when conditions weaken in the future.
We're not seeing that, and that is, I think, a pretty important indicator.
At the risk of being pedantic, I think there's also the premise of the question around resilience. At one level, without a doubt, markets have been impressively solid given the large rise in yields this year. U.S. and European stocks have been posting double-digit gains. Credit spreads, a measure of risk premium, sit near multi-decade lows.
But under the surface, that resilience isn't so apparent. Spreads on the lowest-rated credits, so-called triple CCCs, have increased significantly this year across both the U.S. and Europe. Publicly traded BDCs, which contain portfolios of lower-rated private credit, have traded at widening discounts to their book value.
And even in the mighty U.S. stock market, my colleague Mike Wilson and our U.S. equity strategy team note that over half of the 3000 largest stocks have seen a drawdown of at least 20 percent since June, which happens to be the month that yields started to rise.
2026 may be showing that global growth overall is just less sensitive to higher rates than was initially expected. Large government deficits in the U.S., Europe, and Asia, and large spending on AI may be two reasons why. With growth strong and inflation still too high, rates may be simply seeking out a level that they think will keep things in balance.
But the interest rate that helps balance – this technology and spending boom – are not the same rates that keep a smaller, weaker, or a more indebted company happy. If higher rates are needed to balance things overall, the weaker tails of the market can still suffer.
We've seen this in the past, particularly 2005. Back then, a large U.S. government deficit, booming China CapEx, and significant U.S. housing wealth all helped push up rates. The overall econom y held up for several more years. But weaker parts of the credit market were challenged by those rates more quickly.
We think the same may be true today and therefore favor an upper quality bias. We favor high-yield bonds over loans and decompression across credit indices.
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.

U.S. mortgage rates are hovering around their highest levels in three years. Morgan Stanley Co-Heads of Securitized Products Research Jay Bacow and James Egan examine the forces keeping homeowners locked in and buyers priced out of the housing market.
Read more insights from Morgan Stanley.

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Jay Bacow: Jim, [we’re] getting a lot of questions about mortgage rates. We've been flying across the country talking to people. Are your arms tired?
James Egan: I'm hoping that all the extra flapping will give them just a little bit more definition so we can show them off as we talk about adjustable-rate mortgages.
Jay Bacow: And that is the definition of an ARM. Welcome to Thoughts on the Market. I'm Jay Bacow, co-head of Securitized Products Research at Morgan Stanley.
James Egan: And I'm Jim Egan, the other co-head of Securitized Products Research at Morgan Stanley
Jay Bacow: Today, we're here to talk about mortgage rates: how quickly they've moved, why they're here, where they might go, and what it means for the mortgage and housing market.
It's Thursday, October 8th, at 9am in New York.
Jim, as of this recording, the 10-year is over 5.3 percent. Rates haven't closed this high since 2002. The 30-year mortgage rate is around 7.5 percent. It’s about 150 basis points up since the beginning of February.
James Egan: Right. There have been quick moves in rates that has led to quick moves in mortgage rates. There are a lot of implications to that – from affordability, the housing market, mortgage market.
But when we think about the relationship between mortgage rates and interest rates, Jay, there's also a feedback mechanism there. Convexity hedging is what it's typically called.
Can you discuss the role that that might have played in this current episode? And what we should expect going forward?
Jay Bacow: Sure. So, the biggest driver of mortgage rates is Treasury rates. And Treasury rates are driven by a number of factors, and right now most people would point to inflation expectations and geopolitical concerns.
However, as Treasury rates go higher, homeowners that currently have a mortgage are less likely to move. And because they're less likely to move, that means that the average life of those mortgages that investors own gets longer.
And because mortgage investors typically want to keep their duration profile constant – as the average life of those mortgages gets longer, they are then going to need to either sell those mortgages or sell Treasuries, which will cause yields to go even higher.
And there's a bit of a feedback loop on that, which can pressure yields and mortgage rates even higher.
But what we would say is, at this point, we don't think there's a huge mechanism of that going through at this rate level. The average mortgage rate that homeowners have in America is almost exactly 4.5 percent. Obviously, they're less likely to move as rates go up. But they're 300 basis points out of the money.
So, from that point, it matters. But it didn't matter as much as when rates were a little lower. However, Jim, 7.5 percent mortgage rate – what does this do for housing affordability? Can you put that in context?
James Egan: Yeah. So, if we just think about this in terms of what a 7.5 percent mortgage rate implies for the monthly payment on the median-priced home, we are now up over $325 dollars if we use that 7.5 percent – assuming home prices are where they are today, incomes are where they are today.
That monthly payment's up over $325 from where we are at local lows in February; or where we were at local lows in February. That's a 17 percent increase, in terms of that monthly payment over just a seven-month period.
Jay Bacow: Alright, so, 17 percent increase over a seven-month period, that's kind of scary.
But as you and I have talked about in the past, given the fixed rate nature of the U.S. mortgage market, it's a tad misleading for the average homeowner in America.
So, what does this do to sales? Obviously, it's scary for new homeowners, though.
James Egan: Right. Look, you brought up the implications from a duration perspective, a convexity hedging perspective. All of this is just how the lock-in effect continues to have material implications for the housing market, for mortgage markets.
But yes, these affordability issues – not that bad for homeowners who have an average rate below 4.5 percent. That's not changing. Over 90 percent of the balance or count of mortgages, depending on how you want to look at it, in the United States remains fixed rate. Their payments aren't changing, right?
But the marginal home buyer, things are getting less affordable. I don't like to use the term demand destruction. I think that sounds a little bit too over the top here. But like we are seeing some of our higher frequency or more leading indicator demand metrics show a little bit of softening here.
Pending home sales, past two months, 3 to 5 percent down year-over-year. Purchase applications, which had been very strong, in September, they were down about 10 percent year-over-year. So, look, we were seeing a little bit of demand increases this year. We were up about 2 percent year-to-date through July.
It's a small increase off of a very, very low base. But we think you're going to see with rates at these levels, if we maintain these levels, is effectively the probability or any real ability of the market to escape to the upside from an activity perspective? That probability keeps coming down. And we're going to be stuck in this turnover, very range-bound, lowest level of sales as a percentage of the housing market in 40 years.
Jay Bacow: So really low activity, what does that do to prices? Is there some flow through? Is there relief coming?
James Egan: Look, as demand softens, the kind of first-order expectation or the heuristic should be that prices should soften as well. But again, lock-in effect; what we've actually seen is the rate of growth for existing listings at these levels has slowed. And it's slowed pretty materially.
That's actually led to home price appreciation accelerating over the past few months. We've gone from just 0.7 or 0.8 percent four months ago to 1.9 percent for the data that we just received. We think that that level is kind of sustainable here, and we're going to be between like roughly 2 percent, give or take, for the remainder of this year.
Now, you and I have both been mentioning the lock-in effect throughout the course of this. Yes, an overwhelming majority of the market is fixed rate right now. But the media, our conversations with clients, there's been a lot of discussion of potentially a growing share of adjustable-rate mortgages to kind of help the marginal homeowner with affordability.
What are we seeing in ARMs right now?
Jay Bacow: Okay. Yeah, so great question, and we are seeing a pickup in ARM issuance. If we look at the percentage of mortgages that were ARMs through the first half of this year and compare them to the percentage of ARMs in the first half of last year, it's increased by about 1 percent on aggregate issuance. It's went from about a little over 15 percent to a little over 16 percent.
And so, 1 percent increase is not a huge number by itself, but when we're talking about a little over $2 trillion of expected issuance in the course of the year across the entire mortgage market, this does help on the margin. And we do think, as we said in the past, that more uptake of ARMs would likely be a little bit of a positive solution to some of the affordability challenges.
But Jim, if people take out more ARMs, recognizing that most people only have two arms, should we be worrying about a repeat of the financial crisis and lending standards?
James Egan: So, this is a question that we get a lot when we start talking about moving away from fixed-rate mortgages. And the point that I want to stress; that we want to stress here, is not all ARMs are created equal…
Jay Bacow: Mine are stronger than yours?
James Egan: Sure, we'll go with that. But also, if we control for borrower characteristics, right? Credit scores, loan-to-value ratios, debt-to-income ratios, right? And then we compare performance of adjustable-rate mortgages to fixed-rate mortgages, 7-1 ARMs, 10-1 ARMs, they perform very much like fixed-rate mortgages.
It's really the short-reset ARMs, what we'll call affordability products. So, they only have 24-month or 36-month fixed periods. Those are what have historically showed a much higher rate of default and something that would get us a little bit more concerned about lending standards if those were the products we're talking about.
Thankfully, they're not right now. The ARM growth that we're seeing is in the 5-1, 7-1, 10-1 space. Those have historically, again, controlling for borrower performance, performed like fixed-rate mortgages. And so, we think that you can expand mortgage product into ARMs and do it responsibly.
Jay Bacow: All right. Jim, always a pleasure speaking with you.
James Egan: And always great speaking to you too, Jay. And to all of our regular listeners out there, thank you for adding us to your playlist. Let us know what you think wherever you get this podcast, and share Thoughts on the Market with a friend or colleague today.
Jay Bacow: Go smash that subscribe button.