Our Global Chief Economist explains why a predictable end to 2024
for central banks may give way to a tempestuous 2025.
----- Transcript -----
Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan
Stanley's Global Chief Economist, and today I'll be talking about
how the year end is wrapping up with, surprisingly, a fair amount
of certainty about central banks.
It's Tuesday, December 17th at 10 a. m. in New York.
Unlike the rest of this past year, year end seems to have a lot
more certainty about the last few central bank
meetings. Perhaps it is just the calm before the storm, but
for now, let's enjoy a benign central bank week ahead of the
holidays. Last Thursday, the ECB cut interest rates 25 basis
points, right in line with what we were thinking and what the
market was thinking. Similarly, but I have to say, with a pretty
different narrative, we expect the Fed to cut 25 basis points
this week and the market seems to be all in there as well.
The Bank of England, the Bank of Japan, well, we think they're
closed accounts; that is to say, they're going to be on pause
until the new year. Last week's 25 basis point cut by the ECB
came amidst a debate as to whether or not the ECB should
accelerate their pace of rate cuts. With most doubts about
disinflation resolved, it’s downside growth risks that have
gained prominence in the decision making process there.
Restrictive monetary policy is starting to look less
and less necessary and President Lagarde’s statement
seems to reflect that the council's negotiated stance, that
easing will continue until the ECB reaches neutral. The question
is what happens next? In our view, the ECB will come to see
there's a need to cut through neutral and get all the way down to
1%.
In stark contrast, there's the Fed, where there are very few
residual growth concerns, but there have been more and more
questions about the pace of disinflation. The recent employment
data, for example, clearly suggests that the recession risk is
low. Some members on the committee have started to express
concerns, however, that inflation data really have proven
stickier and that maybe the disinflation process is stalled.
From our perspective, last week's CPI data and all the other
inflation data we just got really point to the next PCE print
showing continued clear disinflation, leaving very little room
for debate for the Fed to cut 25 basis points in December. And
indeed, if it's as weak as we think it is, that provides extra
fuel for a cut in January.
That said, our baseline view of cuts in March and May are going
to get challenged if future data releases show a reversal in this
disinflationary trend, if it's from residual seasonality or maybe
pass through from newly imposed tariffs, and Chair Powell's
remarks at next week's press conference are really going to be
critical to see if they really are becoming more cautious about
cuts.
Now, we don't expect the Bank of England or the Bank of Japan to
move until next year. The recent currency weakness in Japan has
raised the prospect of a rate hike as soon as this month, but
we've kept the view that a January rate hike is much more likely.
The timing would allow the Bank of Japan to get greater insight
into the Shunto wage negotiations, and that gives them greater
insight into future inflation. And recent communications from the
Bank of Japan also aligns with our view and in particular,
there is a scheduled speech by Deputy Governor Himino on January
14th, one week before the January 23rd and 24th meeting. All
of that says the stars are lined up for a
January rate hike. Market pricing over the past couple
weeks have moved against a hike in December and towards our call
for a hike in January.
Now, the market's also pricing the next Bank of England cut to be
next year rather than this year. We expect those cuts to come at
alternating meetings. December on pause, a cut in February, and
gradual rate cuts thereafter. Now, services inflation, the key
focus of the Bank of England so far, has remained elevated
through the end of the year, but we expect to see mounting
evidence of labor market weakness, and as a result, wage growth
deceleration, and that, we think, is what pushes the MPC towards
more cuts. All of that said, the recent announcement of fiscal
stimulus in the UK starts to raise some inflationary risks at the
margin.
All right, well, as the year comes to an end, it has
been quite a year to say the least. Elections
around the world, not least of which here in the United States,
wildly swinging expectations for central banks, and a structural
shift in Japan ending decades of nominal stagnation.
And I have to say an early glimpse into 2025 suggests that the
roller coaster is not over yet. But for now, let's take some
respite because there should be limited drama from central banks
this week. Happy holidays.
Well, thanks for listening, and if you enjoy the show, please
leave us a review wherever you listen and
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today.
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