Default rates are peaking: Morgan Stanley CIO of Global Fixed Income

Michael Kushma - Morgan Stanley Investment Management CIO of Global Fixed Income joins Yahoo Finance and projects default rates could easily hit 10% in high yield markets but said the bottom is in sight.

Video Transcript

JULIE HYMAN: Let's get to more on what's going on in these markets here. As I say, kind of a sideways move that we're seeing in today's session, as we consider the lack of stimulus agreement and we also consider the economic data out today. Retail sales up 1.2% in July. That's the third straight monthly increase, although the magnitude of the gains has been moderated. We've just about reached the same level of retail sales that we were at before the pandemic. But what will happen with stimulus checks not arriving?

Michael Kushma is joining us now. He is Morgan Stanley Investment Management chief investment officer of global fixed income. Michael, it's always good to talk to you. So we continue-- today notwithstanding, today was a little bit mixed. But week are seeing risk on, generally, in the markets here. As we see the 10-year yield, it's nearly 0.7% here today. Do you think that that will be sustained? Do you think that the tug of war between the optimists and the pessimists, the optimists will continue to win out?

MICHAEL KUSHMA: I think so in the short term, at least. Obviously, the the gridlock in Washington on the new stimulus package is a worry if they procrastinate too long getting it done. It's been one of our core beliefs that they will agree to a package at some point of a reasonable size. And clearly, that has been postponed, in terms of implementation.

But in terms of the optimists versus pessimists, clearly the news on vaccine possibilities, as well as the decline in cases-- infection cases-- in the United States is still high but declining in several states is an optimistic development over time. Plus, we still have policy very supportive, monetary policy in particular. And we don't expect treasury yields to rise very much from current levels. We don't think the Fed would be too much in favor of that, and they will make noises come September if, in fact, yields do move higher.

ADAM SHAPIRO: Are you concerned in any way, though, about inflation perhaps becoming an issue sooner than later? We've had guests say short term, don't worry. But a year two years out, it does become an issue.

MICHAEL KUSHMA: I think that's still the-- a right attitude that the longer term, we do expect economies to recover with stimulus, with vaccines and other therapeutic measures. And that will help the economy grow faster and cause demand to rise and inflation to rise, especially with the Fed, I think, remaining very supportive through the recovery phase in 2021 into 2022.

In the short term, I think inflation is definitely lower than it was before the pandemic, and it has bounced strongly recently in the Consumer Price Index report. But there's a lot of technical factors going on in calculating inflation, demand for various products. I'm not taking it seriously as a change in short-term trends. We think inflation will stay low, lower than it was before the pandemic broke out, through the middle of next year probably, until something happens more materially with aggregate demand and the economy recovering.

RICK NEWMAN: Hey Michael, Rick Newman here. You did not mention the presidential election as part of your outlook. Is it possible that a Joe Biden victory is actually a fairly benign development for financial markets, whether it comes with Democratic control of the Senate or not?

MICHAEL KUSHMA: Well, it's a good question. I think that the polls are suggesting he's in the lead. Given what happened in 2016, I think it's premature to count that the Democrats are going to are going to win or sweep Washington.

And I think that Joe Biden has come across as a-- more of a centrist. And I don't think right now, given the challenges the US economy faces as well as the global economy faces, that macro-economic policy will change that much. We need more stimulus from Washington on the fiscal side, and monetary policy is likely to stay easy going into next year. So that backbone of government influence, in terms of actual spending and interest rates, are likely to remain very supportive, who-- either party wins.

JULIE HYMAN: Michael, one thing we haven't talked about is the high-yield market, and I know that's an area that you are watching. You say default rates could easily hit 10% there. What are the implications there-- I mean, not just for an investor who would potentially be investing in high yield, but in terms of any kind of ripple effect?

MICHAEL KUSHMA: It's very good question. Defaults have definitely been on the rise this year after being very subdued for a number of years, near-- probing near all-time lows for the last couple of years prior to this year. And the problems which are faced by several industries-- the energy industry in the United States, the leisure industry, entertainment industry, hotels, retailing-- have clearly led to main brands' default to bankruptcy in recent recent months, and that's not likely to diminish, in terms of the pressures on many sectors of the economy.

But we think we're reaching the absolute nadir, the bottom, of what's going on in the economy. And things should improve, albeit gradually in certain cases, but get better from here. And yes, it is possible default rates in aggregate will reach 10%, but they should remain very concentrated in certain industries, like we've seen so far this year.

We don't think it'll spill over more broadly to the economy, which would be worrisome, if the economy did not recover, such that other sectors in the economy-- cable, communications, gaming, whatever else is in the high-yield index-- they suffer more challenges going forward. We do not think that's likely, but it is possible.

So we do think the default rates are peaking-- will peak somewhere between 8% and 10% between now and year end. But that should be it, if everything else falls into place. And more fiscal stimulus is one of those things which need to fall into place.

JULIE HYMAN: We'll see if they can get it done, even in September. Thank you, Michael. Good to talk to you. Michael Kushma is Morgan Stanley Investment Management CIO of global fixed income.