Transcript:
Caroline Woods
Joining me now, Andrew Szczurowski Co-head of Mortgage and Securities Investments at Morgan Stanley Investment Management. Andrew, thanks so much for joining us.
Andrew Szczurowski
Thanks for having me.
Caroline Woods
Let’s start by talking about your expectations for the fed, because the market keeps changing its mind about what the fed is going to do next month. There’s been a lot of noise and a lot of data gaps. Do you think we’ll get another rate cut next month?
Andrew Szczurowski
Yeah, I think we’re we’re, you know, having that data black hole that we had for the during the government shutdown makes it tougher on the fed. But I think we’re going to ultimately get a December rate cut followed by a couple more next year. And I think that the reason why is that we have a continued weakening labor market.
Andrew Szczurowski
If the fed was planning on eventually cutting back towards neutral, that was the plan before the government shutdown. They weren’t going to do just that one cut in kind of October. And then stop. So I think that they want to continue with the plan, provide a little more stimulus to the economy. We’re still above neutral, so it makes sense to continue kind of cutting if you have this weakening labor market, despite the fact that inflation’s a little above, above where they would like it to be.
Andrew Szczurowski
The general trend in inflation continues to be as we go into next year, we kind of pass off some of this tariff inflation. We’re going to be getting closer to both the inflation target. And then they’ll be kind of missing on the labor side.
Caroline Woods
Let’s talk about the weakening labor market. Because in your notes you said it could be that the punch in the face that disrupts the Fed’s plan. What could that look like? And how far off are we from seeing that.
Andrew Szczurowski
Yeah. So look the fed it’s tough for the fed to to kind of they set a goal based on where they think the labor market will be based on where they think inflation will be. And that’s where we get the dot plot. We get their kind of economic forecasts. But and the fed can’t go out there and project a, you know, two week of a labor market because sometimes it can become a self-fulfilling prophecy.
Andrew Szczurowski
And so I said that kind of there’s the old Mike Tyson quote where everyone has a plan until they get punched in the face. And so ultimately, I think the problem we have is that when you look at the strength of the economy and where it’s coming from, it’s not necessarily generating a ton of jobs. You know, we have obviously this big kind of AI data center boom that’s adding a lot to kind of aggregate GDP growth, but it’s not necessarily translating into the same kind of labor growth we’ve seen.
Andrew Szczurowski
And so I think that we talk about a k-shaped recovery for the consumer. I think we also have a k-shaped recovery among among corporations where not everyone’s feeling this kind of 2 to 3% economic growth environment. And because of that, I don’t think that the same that same 2 to 3% GDP growth, if we have that over the coming quarters, it doesn’t get it’s not going to translate to the same hiring that we’ve seen in past cycles, which means the Fed’s going to ultimately want to provide a little more stimulus.
Andrew Szczurowski
Again, the Fed’s above neutral. There’s no reason that you can’t continue cutting, at least to neutral till you kind of feel your way to see if we need to be more stimulative. You at least don’t want to be restrictive. And that’s where they are today.
Caroline Woods
Okay. So what could that labor market weakness and what will additional cuts from the fed mean for fixed income investors.
Andrew Szczurowski
Look, I think it basically means the same thing we saw here in 2025, which is that you’re going to continue to get coupon plus returns because you’re going to you’re going to benefit from this duration tailwind. So if the if the fed ultimately cuts more than the market’s expecting what does that mean. Well it means that the front to belly the yield curve should kick should continue to come down.
Andrew Szczurowski
Because when you look at the fed funds forecast that the market is pricing in we think it’s still too high. So there’s going to be some benefit to owning taking interest rate risk. But doing it at the front belly of the curve, the long end of the curve could be anyone’s guess. There’s you know, we have to price in what what’s going to term premium going to ultimately be where how much supply do we have.
Andrew Szczurowski
And not just in the US but globally. And so that those are all issues with the back end of the curve, the front of the curve, the fed controls that and then the market controls the back end of the curve. And so I think what it means is that you want to take interest rate risk more than, than, you know, your average benchmark would say.
Andrew Szczurowski
And so do that. But also, you know, have a kind of more well-rounded portfolio. Be diversified, not just here in the United States, but but take some other developed market and emerging market interest rate risk as well. Some of those countries are going to benefit as as the dollar comes down and weakens and people look to diversify out of that dollar.
Caroline Woods
Okay. So break it down for us a bit more about what taking risk, but also being diversified means in fixed income and where those opportunities actually are.
Andrew Szczurowski
Yeah, it’s a great question. And I think that when you look at some of the trades that have worked this year and why they might work next year and where you want to be, look, I mentioned taking interest rate risk. And so if if the economy’s weakening and the labor market is weakening, what else. What does that mean kind of sector level.
Andrew Szczurowski
Well, it means that at the corporate level, maybe, you know, the top decile of corporate spreads like we’re at in kind of IgG and high yield, maybe those sectors are a little tight. So maybe you want to kind of move outside of those into some maybe less traditional spaces like securitized products. And so we have a bit of a barbell approach where we think that like agency mortgage backed securities look very attractive.
Andrew Szczurowski
Spreads are still wide of their 50th percentile over the last decade. So that’s one place you can kind of hide out at the higher quality end. But then also if you go into something like commercial mortgage backed these, there’s a space that’s been beat up much over the last decade. When you think about commercial mortgage backed. So one of the longest duration sectors out there, commercial real estate had a lot of pain because of rising interest rates.
Andrew Szczurowski
It also will be a nice tailwind if interest rates come down. The fed cuts more aggressively. You’ll get kind of this two fold benefit of falling interest rates and falling cap rates on those buildings, but also then that that should lead to some spread compression as, as more kind of money comes into the sector. So those are two of our favorite sectors.
Andrew Szczurowski
But again, outside of that you could also move into emerging markets again, that there’s been this kind of flight out of emerging markets for many years. And just in the last quarter, too, we’ve seen the technicals change where money’s coming into those countries. And it’s having this broad base effect of kind of pulling spreads down in those countries, you know, kind of across the board.
Caroline Woods
So you just recently launched the Eaton Vance Income Opportunities ETF, the XAGG Does that offer that barbell approach and exposure to emerging markets. What gap does that fill for investors?
Andrew Szczurowski
Yeah. Look when you think about how investors are typically positioned in fixed income, they have a ton of core exposure or core plus. And so that means you’re getting a lot of exposure to the treasuries. You’re getting a lot of exposure to investment grade corporates. Some of the kind of tighter spread products that we see. But what they’re not getting enough of, we found when we look in kind of broad based, is that they don’t have those kind of satellite sectors of fixed income that offer a lot more yield, a lot more spread, and can really offer some diversification at the same time.
Andrew Szczurowski
So XAGG is our is our kind of multi-sector fixed income fund. We recently launched and and this is a product that, you know, goes around and takes the strips out those kind of best ideas and taxable fixed income. We have a kind of a large team here. Over 200 investment professionals at Morgan Stanley Investment Management that are searching not just in the United States but across the globe.
Andrew Szczurowski
And so we’re trying to pull together in a kind of prudent, prudent fashion, these best opportunities. But doing it in a a bit of a barbell approach, like I mentioned earlier. But we have one main constraint and that has weighted average investment grade. So it’s not like there’s some kind of unhinged fund going so, so far off the risk spectrum.
Andrew Szczurowski
That’s not this at all. This is the strategy that we run in an open in full form since 1990. And so we’ve found it has great returns. If you look over the last kind of five years, this is kind of dramatically outperformed, you know, your typical ag investment without taking too much more risk again, is a barbell approach.
Andrew Szczurowski
But we think that makes sense to go into again, have that emerging markets, securitized products, corporate credit. And let us toggle between those and find the best relative value opportunities when they when they come up.
Caroline Woods
Okay. So just finally, Andrew, what’s your advice to investors who look at S&P 500 returns of what, 15% in 2025 and say, why would I want 3.8% fixed income levels of returns.
Andrew Szczurowski
Yeah, I mean, it’s something that it didn’t make sense when interest rates in where we were in 2020 2021, where you had a ten year that was sub 1%, there was there was very little upside in fixed income from there. And that was something that I remember running funds back then. It was like, who’s going to invest in this?
Andrew Szczurowski
And what is the kind of long what does this mean long term for fixed income? When you think about fixed income returns, you know your returns are going to be heavily centered around that yield that that you’re investing in. And, you know, could be plus or minus depending on what interest rates do and what spreads do. But, you know, X is a product that has a 7% yield.
Andrew Szczurowski
And so in it, you know, over the long term, if you just hold these bonds to maturity, your return is going to be kind of centered around that 7%. If we get some calls, right and some duration calls right, some curve calls right, then you’re looking at Coupon plus. And I think that the that the real benefit today is that base treasury yields are high.
Andrew Szczurowski
There’s still some attractive opportunities in some of these satellite sectors of fixed income. And so the nice thing is that with these base yields high is that treasuries and fixed income act as a hedge. Again on those risk assets when base yields are high. The reason why it didn’t work in 22 was because bases so low and inflation was high.
Andrew Szczurowski
But if we get some risk off event, you will see a flight to quality back into treasuries, back into something like agency mortgage backs. And so that’s when it that’s when it really works for for your kind of investor who’s in a balanced kind of portfolio. And when inflation is coming down it’s when inflation is rising that’s a problem.
Andrew Szczurowski
But we don’t think inflation is going to be a problem a year from now. We think once the tariff inflation passes through, we’re going to be back towards that kind of 2010 to 20 cycle we’re in where inflation is running around 2% plus or minus a little bit. But but that that offers a huge benefit to investors again given how high yields are.
Caroline Woods
All right. We’ll leave it there Andrew Szczurowski, Co-head of Mortgage and Securities Investments at Morgan Stanley Investment Management. Thank you so much for your insights and shedding some light on XAGG
Andrew Szczurowski
Thanks for having me.
#Feds #move #gamechanger #bonds