Morgan Stanley IM: Several bangs and one whimper

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Volatility in yields remained remarkably muted, and spreads continued to compress in a benign fashion—despite a brief spike following the early-month U.S. jobs data. This calm seemed out of sync with developments that, under normal circumstances, might have triggered more pronounced market reactions. Beneath the surface, however, pressures are building that could spill into more significant moves as we head into fall.

Our theme this month echoes T.S. Eliot’s sentiment: summer ends not with a bang, but a whimper. Yet perhaps a more fitting metaphor comes from naturalist Joseph Wood Krutch, who wrote, “August creates as she slumbers, replete and satisfied.” The seeds of potential volatility have been sown—and while markets may appear quiet, they are quietly preparing for what’s next.

Rates Rally on Weak Jobs Data and Dovish Signals
Developed market curves steepened in August as soft U.S. payrolls and dovish Fed commentary fueled expectations for rate cuts. Political instability in France and concerns over Fed independence added long-end pressure. The U.S. dollar weakened broadly, supporting high-carry currencies.

Emerging Market Debt Gains Amid Dollar Weakness and Policy Easing
Emerging markets (EM) posted solid returns, supported by continued inflows and easing from Turkey and Mexico. Trade tensions persisted, but a U.S.-China truce helped stabilize sentiment. EM currencies benefited from dollar softness and attractive real yields.

Credit Markets Mixed as Issuance Picks Up
Investment grade (IG) credit saw modest spread widening, led by French assets, while high yield (HY) and convertibles rallied on strong risk appetite and falling yields. Primary issuance was active across segments, with refinancing dominating supply. Fundamentals remain solid, but spreads are tight.

Securitized Credit Stable with Strong Technicals
Agency mortgage-backed securities (MBS) spreads tightened but remain wide historically. Asset-backed securities, Commercial MBS, and Residential MBS issuance was well absorbed despite seasonal slowdown. Performance was solid, though shorter duration limited upside versus other sectors.

RISK CONSIDERATIONS
Diversification neither assures a profit nor guarantees against loss in a declining market.

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g., natural disasters, health crises, terrorism, conflicts, and social unrest) that affect markets, countries, companies, or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g., portfolio liquidity) of events. Accordingly, you can lose money investing in a portfolio. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Certain U.S. government securities purchased by the strategy, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the U.S. It is possible that these issuers will not have the funds to meet their payment obligations in the future. Public bank loans are subject to liquidity risk and the credit risks of lower-rated securities. High-yield securities (junk bonds) are lower-rated securities that may have a higher degree of credit and liquidity risk. Sovereign debt securities are subject to default risk. Mortgage- and asset-backed securities are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market, and interest rate risks. The currency market is highly volatile. Prices in these markets are influenced by, among other things, changing supply and demand for a particular currency; trade; fiscal, money and domestic or foreign exchange control programs and policies; and changes in domestic and foreign interest rates. Investments in foreign markets entail special risks such as currency, political, economic and market risks. The risks of investing in emerging market countries are greater than the risks generally associated with foreign investments. Derivative instruments may disproportionately increase losses and have a significant impact on performance. They also may be subject to counterparty, liquidity, valuation, and correlation and market risks. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Due to the possibility that prepayments will alter the cash flows on collateralized mortgage obligations (CMOs), it is not possible to determine in advance their final maturity date or average life. In addition, if the collateral securing the CMOs or any third-party guarantees are insufficient to make payments, the portfolio could sustain a loss.