Investors’ Focus Shifts to Rates and AI

Following meetings across Europe and Asia, our Global Head of Cross-Asset Strategy Research, Serena Tang, discusses two of the main themes on investors' minds: uncertainty around U.S. monetary policy and increasing caution toward AI despite its long-term potential.Serena Tang: Welcome to Thoughts on the Market. I'm Serena Tang, Global Head of Cross-Asset Strategy Research at Morgan Stanley.And today, I'm bringing you a debrief from my investor meetings across Europe and Asia, and the key debates around AI and the Fed.It's Thursday, July 2nd at 10am in New York.The last two weeks, I have been traveling in Europe and Asia to meet with investors to discuss Morgan Stanley's latest views. Two themes dominated nearly every room I walked into.The first is the Federal Reserve and monetary policy path in the U.S. Many investors had interpreted Chair Kevin Warsh's June FOMC meeting, his first at the helm, as unambiguously hawkish. What market investors at my meetings pointed out is that [the] Fed's Summary of Economic Projections – commonly shortened to SEP, which details policymakers' forecasts for macro metrics like GDP growth, inflation, and the federal funds rate – added a hike in 2026 and pushed out rate cuts, implying more restrictive policy.Now, Morgan Stanley's economists think that hikes implied by SEP at the June FOMC meeting should be interpreted with caution. The projections appeared conditioned on elevated near-term inflation and may not capture the disinflation from a straight reopening. We actually anticipate a lower path for core inflation given a combination of a reversal in travel-related inflation and tariff payback, which lead to our call that the Fed remains on hold through 2026.The second recurring theme in meetings with investors across regions is, unsurprisingly, AI. While in every single meeting investors believe firmly in the secular story of ongoing AI CapEx cycle, there was some unease – especially since AI is now also becoming an inflation story on the macro side and a funding story on the micro side.Chipflation is a new word in town, with markets still debating whether it can be one of the things that derail the AI CapEx cycle. In our economists’ and sector analysts’ views, it's more nuanced. While memory price is up sixfold over the past year, we think chipflation is more likely to reprice and ration AI infrastructure than derail the cycle. AI demand is scaling across three layers at once, more memory per chip, more chips per system, and more systems per cluster, while hyperscalers remain first in the allocation queue. Now, the key risk is CapEx efficiency. Memory is becoming a larger share of the AI system cost, but the cycle, we think, remains intact.As for AI funding needs, the debate with investors has been how much more can it accelerate? It's worth noting that the majority of corporate bond issuance quarter-to-date has been related to funding construction of data centers.Hyperscale’s have been broadening their investor base through non-dollar issuances. They have collectively issued around $25 billion of debt in other currencies like euro, Swiss franc, and the [Japanese yen] in May.Our credit strategy colleagues forecast nearly another $600 billion of AI-related global issuance in 2026; meaning for U.S. IG corporate bonds alone, we expect one trillion of net issuance, a reason for our view that the asset class can underperform this year. With our equity colleagues estimating hyperscaler cash CapEx to surpass $1 trillion in 2027, we expect issuance to accelerate.Bringing it all together, investors globally are all grappling with the same uncertainties around the Fed and AI CapEx, which will likely continue to be key debates to come. But Morgan Stanley's base case view of lower inflation driving the Fed to stay on hold and a strong AI CapEx cycle that remains intact means we recommend investors should still stay constructive on risk assets.Thanks for listening. Let us know what you think by leaving a review. And if you enjoyed the podcast, please share Thoughts on the Market with a friend or colleague today.