The ever-evolving nature of the U.S. administration’s trade policy has triggered market uncertainty, impacting corporate and consumer confidence. But our Head of Corporate Credit Research Andrew Sheets explains why he believes this volatility could present a silver lining for credit investors.
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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 how high uncertainty can be a risk for credit, and also an opportunity.
It's Wednesday, April 16th at 9am in New York.
Markets year-to-date have been dominated by questions of U.S. trade policy. At the center of this debate is a puzzle: What, exactly, the goal of this policy is?
Currently, there are two competing theories of what the U.S. administration is trying to achieve. In one, aggressive tariffs are a negotiating tactic, an aggressive opening move designed to be bargained down into something much, much lower for an ultimate deal.
And in the other interpretation, aggressive tariffs are a new industrial policy. Large tariffs, for a long period of time, are necessary to encourage manufacturers to relocate operations to the U.S. over the long term.
Both of these theories are plausible. Both have been discussed by senior U.S. administration officials. But they are also mutually exclusive. They can’t both prevail.
The uncertainty of which of these camps wins out is not new. Market strength back in early February could be linked to optimism that tariffs would be more of that first negotiating tool. Weakness in March and April was linked to signs that they would be more permanent. And the more recent bounce, including an almost 10 percent one-day rally last week, were linked to hopes that the pendulum was once again swinging back.
This back and forth is uncertain. But in some sense, it gives investors a rubric: signs of more aggressive tariffs would be more challenging to the market, signs of more flexibility more positive. But is it that simple? Do signs of a more lasting tariff pause solve the story?
The important question, we think, is whether all of that back and forth has done lasting damage to corporate and consumer confidence. Even if all of the tariffs were paused, would companies and consumers believe it? Would they be willing to invest and spend over the coming quarters at similar levels to before – given all of the recent volatility?
This question is more than hypothetical. Across a wide range of surveys, the so-called soft data, U.S. corporate and consumer confidence has plunged. Merger activity has slowed sharply. We expect intense investor focus on these measures of confidence over the coming months.
For credit, lower confidence is a doubled edged sword. To some extent, it is good, keeping companies more conservative and better able to service their debt. But if it weakens the overall economy – and historically, weaker confidence surveys like we’ve seen recently have indicated much weaker growth in the future; that’s a risk. With overall spread levels about average, we do not see valuations as clearly attractive enough to be outright positive, yet.
But maybe there is one silver lining. Long term Investment grade corporate debt now yields over 6 percent. As corporate confidence has soured, and these yields have risen, we think companies will find it unattractive to lock in high costs for long-term borrowing. Fewer bonds for sale, and attractive all-in yields for investors could help this part of the market outperform, in our view.
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