Morgan Stanley’s chief economists examine the varied responses of
global central banks to noisy inflation data in their quarterly
roundtable discussion.
----- Transcript -----
Seth Carpenter: Welcome to Thoughts on the
Market. I'm Seth Carpenter, Morgan Stanley's global chief
economist. We have a special two-part episode of the podcast
where we'll cover Morgan Stanley's global economic outlook as we
look into the third quarter of 2024.
It's Friday, June 21st at 10am in New York.
Jens Eisenschmidt: And 4pm in Frankfurt.
Chetan Ahya: And 10pm in Hong Kong.
Seth Carpenter: Alright, so a lot's
happened since our last economics roundtable on this podcast back
in March and since we published our mid-year outlook in May. My
travels have taken me to many corners of the globe, including
Tokyo, Sao Paulo, Sydney, Washington D. C., Chicago.
Two themes have dominated every one of my meetings. Inflation in
central banks on the one hand, and then on the other hand,
elections.
In the first part of this special episode, I wanted to discuss
these key topics with the leaders of Morgan Stanley Economics in
key regions. Ellen Zentner is our Chief US Economist, Jens
Eisenschmidt is our Chief Europe Economist, and Chetan Ahya is
our Chief Asia Economist.
Ellen, I'm going to start with you. You've also been traveling.
You were in London recently, for example. In your conversations
with folks, what are you explaining to people? Where do things
stand now for the Fed and inflation in the US?
Ellen Zentner: Thanks, Seth. So, we told
people that the inflation boost that we saw in the first quarter
was really noise, not signal, and it would be temporary; and
certainly, the past three months of data have supported that
view. But the Fed got spooked by that re-acceleration in
inflation, and it was quite volatile. And so, they did shift
their dot plot from a median of three cuts to a median of just
one cut this year. Now, we're not moved by the dot plot. And
Chair Powell told everyone to take the projections with a grain
of salt. And we still see three cuts starting in September.
Jens Eisenschmidt: If you don't mind me
jumping in here, on this side of the Atlantic, inflation has also
been noisy and the key driver behind repricing in rate
expectations. The ECB delivered its cut in June as expected, but
it didn't commit to much more than that. And we had, in fact,
anticipated that cautious outcome simply because we have seen
surprises to the upside in the April, and in particular in the
May numbers. And here, again, the upside surprise was all in
services inflation.
If you look at inflation and compare between the US experience
and euro area experience, what stands out at that on both sides
of the Atlantic, services inflation appears to be the sticky
part. So, the upside surprises in May in particular probably have
left the feeling in the governing council that the process -- by
which they got more and more confidence in their ability to
forecast inflation developments and hence put more weight on
their forecast and on their medium-term projections – that
confidence and that ability has suffered a slight setback. Which
means there is more focus now for the next month on current
inflation and how it basically compares to their forecast.
So, by implication, we think upside surprises or continued upside
surprises relative to the ECB's path, which coincides in the
short term with our path, will be a problem; will mean that the
September rate cut is put into question.
For now, our baseline is a cut in September and another one in
December. So, two more this year. And another four next year.
Seth Carpenter: Okay, I get it. So, from my
perspective, then, listening to you, Jens, listening to Ellen,
we're in similar areas; the timing of it a little bit different
with the upside surprise to inflation, but downward trend in
inflation in both places. ECB already cutting once. Fed set to
start cutting in September, so it feels similar.
Chetan, the Bank of Japan is going in exactly the opposite
direction. So, our view on the reflation in Japan, from my
conversations with clients, is now becoming more or less
consensus. Can you just walk us through where things stand? What
do you expect coming out of Japan for the rest of this year?
Chetan Ahya: Thanks, Seth. So, Japan's
reflation story is very much on track. We think a generational
shift from low-flation to new equilibrium of sustainable moderate
inflation is taking hold. And we see two key factors sustaining
this story going forward. First is, we expect Japan's
policymakers to continue to keep macro policies accommodative.
And second, we think a virtuous cycle of higher prices and wages
is underway.
The strong spring wage negotiation results this year will mean
wage growth will rise to 3 percent by third quarter and crucially
the pass through of wages to prices is now much stronger than in
the past -- and will keep inflation sustainably higher at 1.5 to
2 per cent. This is why we expect BOJ to hike by 15 basis points
in July and then again in January of next year by 25 basis
points, bringing policy rates to 0.5 per cent.
We don't expect further rate hikes beyond that, as we don't see
inflation overshooting the 2 percent target sustainably. We think
Governor Ueda would want to keep monetary policy accommodative in
order for reflation to become embedded. The main risk to our
outlook is if inflation surprises to the downside. This could
materialize if the wage to price pass through turns out to be
weaker than our estimates.
Seth Carpenter: All of that was a great
place to start. Inflation, central banking, like I said before,
literally every single meeting I've had with clients has had a
start there. Equity clients want to know if interest rates are
coming down. Rates clients want to know where interest rates are
going and what's going on with inflation.
But we can't forget about the overall economy: economic activity,
economic growth. I will say, as a house, collectively for the
whole globe, we've got a pretty benign outlook on growth, with
global growth running about the same pace this year as last year.
But that top level view masks some heterogeneity across the
globe.
And Chetan I'm going to come right back to you, staying with
topics in Asia. Because as far as I can remember, every
conversation about global economic activity has to have China as
part of it. China's been a key part of the global story. What's
our current thinking there in China? What's going on this year
and into next year?
Chetan Ahya: So, Seth, in China, cyclically
improving exports trend has helped to stabilize growth, but the
structural challenges are still persisting. The biggest
structural challenge that China faces is deflation. The key
source of deflationary pressure is the housing sector. While
there is policy action being taken to address this issue, we are
of the view that housing will still be a drag on aggregate
demand. To contextualize, the inventory of new homes is around 20
million units, as compared to the sales of about 7 to 8 million
units annually. Moreover, there is another 23 million units of
existing home inventory.
So, we think it would take multiple years for this huge inventory
overhang to
be digested to a more reasonable level. And as downturn in the
property sector is resulting in downward pressures on aggregate
demand, policy makers are supporting growth by boosting supply.
Consider the shifts in flow of credit. Over the past few years,
new loans to property sector have declined by about $700 billion,
but this has been more than offset by a rise of about $500
billion in new loans for industrial sector, i.e. manufacturing
investment, and $200 billion loans for infrastructure. This
supply -centric policy response has led to a buildup of excess
capacities in a number of key manufacturing sectors, and that is
keeping deflationary pressures alive for longer. Indeed, we
continue to see the diversions of real GDP growth and normal GDP
growth outcomes. While real GDP growth will stabilize at 4.8 per
cent this year, normal GDP growth will still be somewhat subdued
at 4.5 per cent.
Seth Carpenter: Thanks, Chetan. That's
super helpful.
Jens, let's think about the euro area, where there had, been a
lot of slower growth relative to the US. I will say, when I'm in
Europe, I get that question, why is the US outperforming Europe?
You know, I think, my read on it, and you should tell me if I'm
right or not -- recent data suggests that things, in terms of
growth at least have bottomed out in Europe and might be starting
to look up. So, what are you thinking about the outlook for
European growth for the rest of the year? Should we expect just a
real bounce back in Europe or what's it going to look like?
Jens Eisenschmidt: Indeed, growth has
bottomed. In fact, we are emerging from a period of stagnation
last year; and as expected in
our NTIA Outlook in November we had
outlined the script -- that based on a recovery in consumption,
which in turn is based on real wage gains. And fading
restrictiveness of monetary policy, we would get a growth rebound
this year. And the signs are there that we are exactly getting
this, as expected.
So, we had a very strong first quarter, which actually led us to
upgrade still our growth that we had before at 0.5 to 0.7. And we
have the PMIs, the survey indicators indicating indeed that the
growth rebound is set to continue. And we have also upgraded the
growth outlook for 2025 from 1 to 1.2 per cent here on the back
of stronger external demand assumptions. So, all in all, the
picture looks pretty consistent with that rebound.
At the same time, one word of caution is that it won't get very
fast. We will see growth very likely peaking below the levels
that were previous peaks simply because potential growth is
lower; we think is lower than it has been before the pandemic. So
just as a measure, we think, for instance, that potential growth
in Europe could be here lie between one, maybe one, 1 per cent,
whereas before it would be rather 1.5 per cent.
Seth Carpenter: Okay, that makes a lot of
sense. So, some acceleration, maybe not booming, maybe not
catching the US, but getting a little bit of convergence. So,
Ellen, bring it back to the US for us. What are you thinking
about growth for the US? Are we going to slump and slow down and
start to look like Europe? Are things going to take off from
here?
Things have been pretty good. What do you think is going to
happen for the rest of this year and into next year?
Ellen Zentner: Yes, I think for the year
overall, you know, growth is still going to be solid in the US,
but it has been slowing compared with last year. And if I put a
‘the big picture view’ around it, you've got a fiscal impulse,
where it's fading, right? So, we had big fiscal stimulus around
COVID, which continues to fade. You had big infrastructure
packages around the CHIPS Act and the IRA, where the bulk of that
spending has been absorbed. And so that fiscal impulse is fading.
But you've still got the monetary policy drag, which continues to
build.
Now, within that, the immigration story is a very big offset.
What does it mean, you know, for the mid-year outlook? We had
upgraded growth for this year and next quite meaningfully. And we
completely changed how we were thinking about sort of the normal
run rate of job growth that would keep the unemployment rate
steady.
So, whereas just six months ago, we thought it was around 100,000
to 120,000 a month, now we think that we can grow the labor
market at about 250,000 a month, without being inflationary. And
so that allows for that bigger but not tighter economy, which has
been a big theme of ours since the mid-year outlook.
And so, I'm throwing in the importance of immigration in here
because I know you want to talk about elections later on. So, I
want to flag that as not just a positive for the economy, but a
risk to the outlook as well.
Now, finally, key upcoming data is going to inform our view for
this year. So, I'm looking for: Do households slow their spending
because labor income growth is slowing? Does inflation continue
to come down? And do job gains hold up?
Seth Carpenter: Alright, thanks Ellen. That
helps a lot, and it puts things into perspective. And you're
right, I do want to move on to elections, but that will be for
the second part of this special episode. Catch that in your
podcast feeds on Monday.
For now, thank you for listening. And if you enjoy the podcast,
please leave a review wherever you listen and share Thoughts On
the Market with a friend or colleague today.
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