In the second of their two-part roundtable, Seth Carpenter
and Morgan Stanley’s top economists break down the forces
influencing growth across different regions.
Read more insights from Morgan Stanley.
----- Transcript -----
Seth Carpenter: Welcome to Thoughts on the
Market. I'm Seth Carpenter, Morgan Stanley's Global Chief
Economist and Head of Macro Research. And yesterday I sat down
with my colleagues, Michael Gapen, our Chief U.S. Economist,
Chetan Ahya, our Chief Asia Economist, and Jen Eisenschmidt, our
Chief Europe Economist. And we spent a lot of time talking about
monetary policy around the world.
Today, let's go back to them, talk about the real side of the
economy.
It's Friday, January 23rd at 10am in New York.
Jens Eisenschmidt: And 4pm in
Frankfurt.
Chetan Ahya: And 9pm in Hong Kong.
Seth Carpenter: Michael, let me start with
you, back on the U.S. And when I think about the U.S. economy, we
have to start by talking about the U.S. consumer.
Walk us through what investors need to understand about consumer
spending in the U.S. What's driving it, what's going to hold it
up, and where are the risks?
Michael Gapen: I think the primary thing to
remember here is that the upper income consumer drives about 40
percent or more of total spending. So, there can be
higher inflation that eats into real labor market income growth.
There can be inflation dispersion, which hits lower income
households more than upper income households. We can have tariffs
that get applied to goods and lower- and middle-income households
buy goods more than upper income households.
But when asset markets continue to appreciate, when home prices
hold on to their prior gains, sometimes that doesn't matter in
the aggregate statistics because that upper income household
keeps spending.
I do think that's a lot of what happened in 2025. So, there is a
K-shaped economy. I think one of the main risks about the U.S. is
that its expansion is narrowly driven. We think that
will broaden out in 2026. If we're right, that inflation comes
down and we're past, kind of, the peak effect of tariffs, then we
think that lower- and middle-income household can have a little
more residual spending power. And you might get the consumer
operating on two fronts, rather than one.
Seth
Carpenter: Another part of
domestic spending that gets a lot of attention is business
investment spending, CapEx spending. First would you agree
with that statement that CapEx spending last year was
characterized by AI CapEx spending? Second, should we feel
confident that that underlying sort of momentum in CapEx spending
should continue for this year? And then third, what's it going to
take for there to be a broadening out, maybe like what you said
about consumers, but a broadening out of investment spending so
that it's not just the AI story that's driving CapEx.
Michael Gapen: I do agree that the
primary, almost exclusive story in 2025 for business spending was
AI. So, when you look at residential and non-residential
spending, unrelated to AI, that I think did feel the effects of
policy uncertainty in a changing environment. what
keeps kind of sustainability around business spending? Obviously,
it's a multi-year investment story around AI. There's a
level versus growth rate argument here where you can have a heck
of a lot of CapEx spending. May not always show up in GDP because
some of it is intermediate goods, some of it is imported. But
that doesn't diminish, I think, the quality of the overall story.
What gets business spending to broaden out, I do think is related
to whether consumer spending broadens out. Most business spending
kind of follows demand with a lag.
So, AI is a different story, but there's a cyclical component to
business spending. There could be a housing related component, if
mortgage rates come down and stimulate at least a little more
turnover in the housing market. So, if the recovery does broaden
out, we see greater real income growth in low- and middle-income
households. The labor market stabilizes. Maybe mortgage rates
come down a little bit, then I think you could get carry through
momentum to non-AI related business spending. That would look
more like a cyclical upswing for the economy. May be a heavy
lift, but that's what I think it would take to get there.
Seth Carpenter: So, Jens, let me come to
you. We talked yesterday about the ECB possibly easing more on
disinflation. But when I think of disinflation, I think of a weak
economy. And that's maybe not really the case. So, I guess the
first question to you would you characterize euro area
economic growth as strong, or a little bit more
complicated?
Jens Eisenschmidt: A little bit more
complicated. And that's always the right answer for an economist
– I think it depends. Well, it is strong in some quarters. And
these quarters will change from where it has been in the past.
So concretely, we think the German economy has most potential to
catch up and actually accelerate, and that's due to fiscal
stimulus mainly. While we have other quarters, the
French and the Italian one, which will be below potential and so
weak – each of them for their own reason. And then we have the
Spanish economy, which performs exceptionally and is really
strong, but it's only a small part of the euro area
economy.
If we had everything together, I think the outlook is an economy
that's accelerating mildly and only towards the end of our
projection horizon, which is [20]27. So, in say two years, hits
growth rates that are above potential. Here we are really talking
about quarterly increments above 0.3. So, we are currently
between 0.1 and 0.2. So, you sort of get the picture of a mildly
accelerating economy that goes from 0.15 to 0.035 say in the span
of two years.
Seth Carpenter: One of the key narratives in
markets is about fiscal policy in Germany, potentially driving
growth. I know in equity markets it’s been a key investing
theme. So how excited should people be about the possibility of
fiscal policy in Germany driving a resilient European
economy?
Jens Eisenschmidt: Pretty excited, I would
say, in a sense that the positioning of the German government for
its economy is actually exceptional in terms of the amount of
fiscal space that exists and that has been made available. It's
just that, of course, the connection of that sort of abstract
excitement that we economists have to what actually happens in
markets is sometimes a little bit loose; in the sense that equity
[markets would like to see everything coming online tomorrow, and
that's going to be a more drawn-out process.
So, to my point before, it will take some time. We do have
implementation lags. We do have lags in say, for instance, on
defense procurement. There is maybe not as much capacity in the
economy to deliver into everything. But the direction of travel
is clear and up. So, from that perspective, I have no doubts that
the future is better for the German economy over the medium term
for all the reasons mentioned, but it won't be immediate. And we
have just seen in recent headlines, Germany is the most trade
exposed European economy. If we get more friction in global
trade, that's not great. So, you could even have short term, more
negative news on GDP than positive ones.
Seth Carpenter: Chetan, I'm going to turn to
you. Yesterday when we talked about Asia, we focused on Japan.
But, of course, when it comes to the real side of the economy,
the big mover in Asia is China.
So, let's talk a little bit about how you see China evolving.
What the key themes are for China. Last year in particular, we
talked a lot about the deflationary cycle in China and how it was
protracted. It wasn't going away. That policy was not sufficient
to drive a huge surge in demand to push things away. Are we in
the same place for China in 2026? What kind of growth should we
expect and what sort of policy reactions should we be expecting
from China?
Chetan Ahya: Well, I think the macro
backdrop for China we think will still be challenging in 2026.
But at the same time, we expect the micro positives to continue.
Now on the macro backdrop, when I say it's going to remain
challenging because the number one issue that we are focused on
from a macro perspective in China is deflation. Now we do expect
some easing of deflationary pressures, but [the] economy will
still stay in deflation in 2026.
And on the micro front what we've seen is that China is emerging
from a situation where it is making inroads into advanced
manufacturing, and that's enabling it to increase market share in
global goods exports. And it's also one of the reasons why when
you see the numbers coming out from China on exports, they seem
to be outperforming. Even just the latest month number as we saw,
China's exports were surprising on the upside relative to market
expectations. And that's the micro story – that you'll see China
continuing to gain market share in global goods export. And that
supports the corporate micro positive story.
Seth Carpenter: We know
collectively that export is a key part of China's economy. The
productive capacity, as you point out, important for China. When
you think about exports from China, the currency has to come in.
And recently the renminbi has been appreciating. Lots of
questions from clients here or there. How important is the
renminbi in reflating or rebalancing the China economy? Can you
walk us through a little bit some of these considerations about
the role that the currency is playing now and over the next few
quarters for China and its economic outlook.
Chetan Ahya: Yeah, that's right, Seth.
Actually, I've been getting a number of clients calling me and
asking whether PBOC is going to allow a significant appreciation
in RNB. We've seen it appreciate quite a lot in the last few
days. And then whether this will mean China's economy will
rebalance faster towards consumption. Look, on the first point,
we don't think PBOC will allow a significant
currency appreciation because, as I just mentioned earlier, the
deflation problem is still there. It's not gone. While we see
reduced deflationary pressures, as long as the economy is in
deflation, it'll be very difficult for PBOC to allow significant
currency appreciation. And what we are also watching on RMB is to
see what is happening to the trade weighted RMB. The RMB basket,
if you were to call it. That interestingly has been in a stable
range since 2016, and we don't think that changes.
We've learned from Japan's experience in the nineties that if you
have deflation problem, you shouldn't be taking up currency
appreciation. And we think PBOC pretty much follows that rule
book. On the rebalancing part, look, I think when you have
deflation and if currency appreciation is going to add to
deflation pressures, that will mean corporate sector revenue
suffers. They will actually be cutting wage growth and therefore
that has a negative impact on consumption. And so, in our view,
instead of helping rebalancing currency appreciation with China's
current macro backdrop, we'll actually be making rebalancing more
difficult.
Seth Carpenter: And of course,
we're used to China being a key driver of the economy, not just
in Asia, but around the world. But if we think about then
broadening out from China, what should we be expecting in terms
of growth for the other economies in Asia?
Chetan Ahya: For the other economies in the
region, I think the most important driver will be what happens to
exports more broadly. In 2025, Asia did benefit from better tech
exports, but because of tariffs and also what was happening in
the U.S. in terms of its own domestic demand, we'd seen that
there was significant weakness in non-tech exports.
So, from an outlook perspective in 2026, we think that that
non-tech export story turns around and that will help the
recovery in the region to broaden out from it just being tech
exports to non-tech exports, to improvement in CapEx, job growth
and consumption. So, I think that the whole region is going
to see the benefit from this turnaround. But particularly the
non-China part of the region will be seeing a meaningful
improvement in their export growth, real GDP growth and normal
GDP growth in 2026.
Seth Carpenter: I'm getting
ready to wrap things up. But before I do, I'm going to ask each
of the three of you, one last rapid-fire question.
Michael, I'm going to start with you. AI is on everyone's lips.
If we were to see a rapid adoption of AI technology across all
the economies. What would it mean for the Fed?
Michael Gapen: Well, I think that would
mean a substantial uptick in productivity growth. Maybe closer to
3 percent like we saw in the tech boom in the nineties. So faster
real growth. But probably still disinflation. You can argue the
Fed could even lower rates in that environment. It may take them
a while to figure it out [be]cause they'd be balancing incoming
data that shows a lot of strong growth. But probably further
evidence that inflation's coming down.
So, if it's supply side driven, then I think you could still
probably get some rate cuts out of the Fed to normalize policy as
inflation comes down. But I'd be thinking those cuts could even
come much later.
Seth Carpenter: Okay, Jens to you, a lot of
discussion in the news about possible additional tariffs from the
U.S. on Europe in some of the negotiations. Suppose some of the
announcements, 10 percent tariffs rising to 25 percent tariffs
later. Suppose those were actually put in place. What does that
mean for European growth?
Jens Eisenschmidt: So, I would say 10
percent additional tariffs, we have a framework for that.
Pointing to drag on GDP growth somewhere between 30 and 60 basis
points. So roughly half of what we think 2026 will bring in
growth. Now, for sure the answer is additional tariffs are not
great for growth. Big question mark here is though whether we get
any retaliation from the European side, which we think this time
around if we get additional tariffs from the U.S. side is more
likely. And that would just increase the downside risk for Europe
here from that additional round of trade or tariff
uncertainty.
Seth Carpenter: Chetan, I'm going to end up
with you. When we think about China, when we think about policy,
what do you think it would take for there to be a fundamental
shift in policy out of Beijing to get a real full blown, demand
driven fiscal stimulus? Or is that just not in the cards
whatsoever?
Chetan Ahya: Well, in our base case, we
don't think that's likely to happen in our forecast horizon. But
if we do get a big social stability challenge emerging in China,
then we could get that big pivot from [a] policy response
perspective, where policy makers move towards consumption. And
our recommendation there is to boost social welfare spending,
particularly targeted towards migrant workers, which could be
taken up if you get that social stability risk event
materializing.
Seth Carpenter: Mike, Chetan, Jens,
thank you so much for joining today. And for the listener, thank
you for joining us. If you enjoy this show, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or a colleague today.
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