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Global financial markets have been highly volatile recently, with cyclical stocks and momentum factors suffering historic drawdowns, and concerns about an economic peak rising sharply.

Andrew Sheets, head of global fixed income research at Morgan Stanley, believes the current sharp price correction is more likely a concentrated unwinding of significant uncertainty than a harbinger of the end of the economic cycle.

At the macro level, several key leading indicators have not signaled a cyclical peak: the global manufacturing PMI remains strong, the U.S. yield curve is still positively sloped, and bank lending growth is accelerating in the United States, Europe, and Asia.

Meanwhile, Democrats scored a historic victory in the U.S. midterm elections, a result that could be positive for bond markets: slower AI data center construction may extend the timeline for related financing, while also potentially reinforcing downward pressure on energy prices.

Morgan Stanley is maintaining its global growth forecasts for the next 6 to 12 months, expecting U.S. economic growth to exceed 2% and Europe’s to exceed 1%. Andrew Sheets said markets may adjust before uncertainty has fully dissipated, particularly after valuation corrections have been quietly underway for some time.

Cycle indicators show no signs of peaking

Andrew Sheets noted that current market volatility is reminiscent of the typical features of past late-cycle periods, but several key indicators do not support that view.

Global manufacturing PMIs remain strong, and recent U.S. PMI data have exceeded expectations. The U.S. Leading Economic Index is showing signs of improvement; bank lending is expanding in the U.S., Europe and Asia; and credit fundamentals continue to improve. The latest readings from Morgan Stanley’s cross-asset team’s cycle model indicate that the economy remains in a healthy range.

Another closely watched indicator—the yield curve—has also issued no warning signals. Whether measured by the 2-year/10-year or 3-month/10-year spread, yield curves in the U.S., U.K., Germany and Japan all remain positively sloped. This runs counter to a scenario in which monetary policy is excessively tight and economic growth is about to turn lower.

Andrew Sheets said that historically, it is rare to see these indicators looking so robust ahead of a major turning point in the cycle.

Midterm election rattles expectations for AI buildout

Democrats scored a significant victory in the U.S. midterm elections, flipping control of the House, Senate and several governorships, including in Texas and Ohio. Their margin of victory was the strongest nationwide overperformance since 1974.

The election results have sparked concerns that AI infrastructure construction could face stricter regulation. However, Andrew Sheets believes this risk, while real, is not the base case—and is not a new concern.

Semiconductor stocks had already fallen about 30% from their June peak before Election Day. Morgan Stanley’s research team has previously written several times that bottlenecks in power and financing could slow the pace of AI construction and extend its timeline.

Even under the most pessimistic, highly constrained scenario—assuming greater challenges with both project approvals and power supply—the forecast compound annual growth rate for global data center capacity through 2030 still stands at 17%.

From an equity market perspective, the risk of delays to the AI buildout must be weighed against the significant valuation adjustment that has already taken place. The S&P 500’s forward P/E ratio is down about 19% year to date. Morgan Stanley equity strategists believe this adjustment has been quietly underway within the market for quite some time.

Bond markets could get a double boost

Andrew Sheets believes the potential positive effects of the midterm election results are more direct for bond markets.

He noted that the two major sources of pressure on bond markets this year—high energy prices and the massive borrowing needed to finance data center construction—could both ease as a result of the election outcome.

• First, a slower pace of AI construction means related financing needs will be spread over a longer period, reducing the supply pressure markets must absorb at any one time.

• Second, according to election analysis cited by Vice President Vance, voter unease over the conflict with Iran was one of the key factors behind the election results. This could lead markets to price in a lower risk premium for a renewed escalation in geopolitical tensions—oil prices are already about 17% below their late-October levels.

Lower energy prices are particularly important for Europe. Morgan Stanley rates strategists currently favor steepening strategies in European yield curves. Morgan Stanley emerging markets strategists also note that lower oil prices will improve emerging market fundamentals in several ways.

In addition, widespread voter dissatisfaction with inflation could further strengthen market expectations that tariffs will ultimately prove to be temporary measures. A larger congressional majority could also limit the ability of individual lawmakers to obstruct legislation, removing one source of market volatility stemming from congressional maneuvering.

Andrew Sheets concluded that the key question now is whether markets are experiencing a genuine turning point in the cycle or approaching the end of a period in which major uncertainties are being resolved all at once.

He leans toward the latter. Cyclical data continue to provide support, while the midterm election results may be easing the two biggest pressures facing bond markets this year. Morgan Stanley will continue to test this view against the evidence as it emerges.