Morgan Stanley's Wilson Sees Need for 150 Bps of Fed Rate Cuts

Bloomberg

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00:00I want to pick up on, I think, a core view of yours for 2025, going into 2026, recessions behind us.

00:06I think that's somewhat unique to you and the team at Morgan Stanley. Just build that out for us.

00:10Yeah, I mean, you know, we try to work six months in the future. I think, you know, a year ago,

00:14I think, remember, we had this conversation after the election. You were saying, Mike,

00:16you sound more optimistic, and I've heard you in a while. And it was kind of, we were thinking six

00:20months in advance. We thought the first half would be tough as they transition from the kind

00:24of growth negative policies to these growth positive policies. All this capex you're talking

00:28about is right in line with the big, beautiful bill. I mean, they're trying to basically reduce

00:32consumption, increase investment. It's a totally different economy. And what that is, it's a

00:37higher velocity economy for all the companies that haven't been doing well for the last, I would say,

00:42three years. We've been sort of in a recession. I would argue strongly. We've done the work on this,

00:46and you know, we've done the analysis with respect to the rolling recession that has been in place

00:50for, I would say, three years. Most of the private economy kind of suffering, government kind of

00:54carrying the water. And then we basically saw all of that come to fruition at the end in April.

00:59April, capitulation day, as I call it, was basically the government recession. That was the final piece

01:04of the rolling recession. And if you actually look at the challenger job cuts, and you look at the

01:09revision data now on the payroll data, it looks to me like a rate of change low, okay, in payrolls,

01:16and a rate of change high in challenger job cuts came in April. So the market's figured all this out.

01:20That's why revision breadth has gone straight up. So rolling recovery, where are we in those stages?

01:25So we deemed it the rolling recovery in April, and we're now seeing that, like these areas of

01:30the market, not everything's going to recover at once, because it's an unorthodox recession. It's

01:34not like everything flushed at once and everything recovers at once. So it is going to be staged.

01:38And we've seen that in the market. We're still narrow, quite frankly. AI, CapEx, is kind of one of the

01:43early recoveries here, semiconductors being an early cycle group. But we're not seeing the other

01:48quote-unquote early cycle groups recover the way they typically do in a new economic cycle. Why?

01:54Because the Fed is behind the curve. The Fed is way behind the curve on rates. They need rates much

01:58lower. If you really want to get the private economy moving, rates are too high. Much lower. How much

02:03lower do you think that really is required to get that broadening out? Well, let's just start with

02:06the two-year treasury yield, okay? So my barometer is always the Fed is behind the curve if Fed funds is

02:13above two-year treasury yields. And in order to stimulate the private economy, I would say they

02:17need to be well below that. So that's 50 basis points just to get to neutral and maybe another

02:21hundred plus to get to something that's more stimulative for the average company and the

02:25average consumer. Are you right now betting on that broadening out and expecting maybe AI to

02:31underperform going forward as they invest more in some of these debt sales and the infrastructure side

02:38and the rest of the economy plays catch-up? Absolutely. Think about the trickle-down effect

02:42of this capital spending. I mean, it's not just going to be semiconductor companies. There's a lot

02:47of infrastructure. There's a lot of job creation. There's a lot of velocity in the real economy.

02:50And the lending channel starts getting going, perhaps for small, medium businesses. That job

02:54creation. Deregulation is another part of that story. Okay, so absolutely, that's what should happen

02:59if things play out the way they could. Now, there's risk to that. Let's say the Fed continues to say,

03:04hey, we still think there's inflation risk. We don't like the inflation rate of 3%. We're not

03:09going to raise our targets there. And then we just kind of drag their feet. It's going to stay

03:13narrow then. It's going to stay up the quality curve. And that's where we are right now, Lisa,

03:17is that people basically are trying to choose between those two outcomes. And I would say right

03:22now, most of the institutional community is still huddled into the high-quality stocks. They

03:25haven't really made the transition yet. Have you? Well, we have in some of our guidance. Yeah,

03:30absolutely. In order for that transition to work, the Fed has to cut, though. That's right.

03:34That's what it's contingent on. It's one of the main things. Now,

03:36dereg is a big part of that. Okay? The capital spending is a part of that. Those can happen

03:40without the Fed cutting significantly. But it would really solidify it for me. And if you go

03:45back and look at all these different economic cycles, small caps and lower-quality stocks

03:50typically don't outperform until the Fed gets below two-year treasury yields. We've documented this.

03:55So, by the way, it doesn't mean these stocks can't work in absolute terms. It just means that

03:59relative outperformance you typically get in that early cycle rotation needs Fed funds to be much lower.

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