- Higher interest rates pressure weaker borrowers despite resilient stock and credit markets
- Economic growth in US, Europe, and Asia remains stronger than expected through 2026
- More than half of top 3,000 US stocks fell 20% from highs amid rising bond yields since June
Higher interest rates may not be enough to derail global economic growth, but they are putting pressure on weaker borrowers even as headline stock markets and credit markets remain resilient, according to Andrew Sheets, Morgan Stanley's global head of fixed income research.
In the latest episode of the bank's Thoughts on the Market podcast, published on Oct. 9, Sheets said economic growth across the US, Europe and Asia had remained stronger than expected through much of 2026, while inflation in several regions remained above central bank targets.
He argued that this does not necessarily mean interest rates are too high for the broader economy. However, companies with weaker credit profiles may struggle to absorb higher borrowing costs as rates rise.
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Credit Stress
Sheets discussed the issue following Morgan Stanley's ninth annual European credit conference in London, which brought together representatives from 50 companies and more than 1,000 investors.
He said US and European stock markets had posted double-digit gains this year, while credit spreads - the additional yield investors demand to hold corporate debt rather than safer government bonds - remained near multi-decade lows.
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However, he said these indicators did not capture the pressure building in weaker parts of the market.
Spreads on triple-C-rated debt, among the lowest-rated categories of corporate credit, had widened significantly this year in both the US and Europe, Sheets said. Publicly traded business development companies, which hold portfolios of lower-rated private credit, had also traded at widening discounts to their book value.
The pressure was also visible in US equities. Citing research by Morgan Stanley's US equity strategy team, Sheets said more than half of the 3,000 largest US-listed stocks had fallen at least 20% from their recent highs since June, when bond yields began to rise.
2005 Parallel
Sheets said large government deficits and spending on artificial intelligence had helped sustain economic activity despite higher interest rates. He noted that AI-related spending had been relatively insensitive to borrowing costs.
He compared the current environment with 2005, when investment booms in China and the US housing market pushed interest rates higher. The wider economy remained resilient for several more years, but weaker parts of the credit market came under pressure earlier.
The same pattern could emerge again, Sheets said, as interest rates needed to balance strong economic activity and spending could still hurt smaller, weaker or more indebted companies.
Morgan Stanley favours higher-quality credit as a result. Sheets said the bank preferred high-yield bonds over loans and expected spreads between different credit-quality segments to widen.
His central argument is that the resilience of the broader economy does not guarantee that all borrowers can withstand higher interest rates. Weaker companies could face mounting pressure even if overall growth remains firm.
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