Original Release Date: November 17, 2025
In the first of a two-part episode presenting our 2026 outlooks,
Chief Global Cross-Asset Strategist Serena Tang has Chief Global
Economist Seth Carpenter explain his thoughts on how economies
around the world are expected to perform and how central banks
may respond.
Read more insights from Morgan Stanley.
----- Transcript -----
Serena Tang: Welcome to Thoughts on the
Market. I'm Serena Tang, Morgan Stanley's Chief Global
Cross-Asset Strategist.
Seth Carpenter: And I'm Seth Carpenter,
Morgan Stanley's Global Chief Economist.
Serena Tang: Today, we'll focus on [the]
all-important macroeconomic backdrop.
Serena Tang: It's Monday, November 17th at
10am in New York.
So, Seth, 2025 has been a year of transition. Global growth
slowed under the weight of tariffs and policy uncertainty. Yet
resilience in consumer spending and AI driven investments kept
recession fears at bay. Your team has published its economic
outlook for 2026. So, what's your view on global growth for the
year ahead?
Seth Carpenter: We really think next year
is going to be the global economy slowing down a little bit more
just like it did this year, settling into a slower growth rate.
But at the same time, we think inflation is going to keep
drifting down in most of the world. Now that anodyne view,
though, masks some heterogeneity around the world; and
importantly, some real uncertainty about different ways things
could possibly go.
Here in the U.S., we think there is more slowing to come in the
near term, especially the fourth quarter of this year and the
beginning of next year. But once the economy works its way
through the tariffs, maybe some of the lagged effects of monetary
policy, we'll start to see things pick up a bit in the second
half of the year.
China's a different story. We see the really tepid growth there
pushed down by the deflationary spiral they've been in. We think
that continues for next year, and so they're probably not quite
going to get to their 5 percent growth target. And in Europe,
there's this push and pull of fiscal policy across the continent.
There's a central bank that thinks they've achieved their job in
terms of inflation, but overall, we think growth there is, kind
of, unremarkable, a little bit over 1 percent. Not bad, but
nothing to write home about at all.
So that's where we think things are going in general. But I have
to say next year, may well be a year for surprises.
Serena Tang: Right. So where do you see the
biggest drivers of global growth in 2026, and what are some of
the key downside risks?
Seth Carpenter: That's a great question. I
really do think that the U.S. is going to be a real key driver of
the story here. And in fact – and maybe we'll talk about this
later – if we're wrong, there's some upside scenarios, there's
some downside scenarios. But most of them around the world are
going to come from the U.S.
Two things are going on right now in the U.S. We've had strong
spending data. We've also had very, very weak employment data.
That usually doesn't last for very long. And so that's why we
think in the near term there's some slowdown in the U.S. and then
over time things recover. We could be wrong in either
direction.
And so, if we're wrong and the labor market sending the real
signal, then the downside risk to the U.S. economy – and by
extension the global economy – really is a recession in the U.S.
Now, given the starting point, given how low unemployment is,
given the spending businesses are doing for AI, if we did get
that recession, it would be mild.
On the other hand, like I said, spending is strong. Business
spending, especially CapEx for AI; household spending, especially
at the top end of the income distribution where wealth is rising
from stocks, where the liability side of the balance sheet is
insulated with fixed rate mortgages. That spending could just
stay strong, and we might see this upside surprise where the
spending really dominates the scene. And again, that would spill
over for the rest of the world.
What I don't see is a lot of reason to suspect that you're going
to get a big breakout next year to the upside or the downside
from either Europe or China, relative to our baseline scenarios.
It could happen, but I really think most of the story is going to
be driven in the U.S.
Serena Tang: So, Seth, markets have been
focused on the Fed, as it should. What is the likely path in 2026
and how are you thinking about central bank policy in general in
other regions?
Seth Carpenter: Absolutely. The Fed is
always of central importance to most people in markets. Our view
– and the market's view, I have to say, has been evolving here.
Our view is that the Fed's actually got a few more rate cuts to
get through, and that by the time we get to the middle of next
year, the middle of 2026, they're going to have their policy rate
down just a little bit above 3 percent. So roughly where the
committee thinks neutral is.
Why do we think that? I think the slowing in the labor market
that we talked about before, we think there's something kind of
durable there. And now that the government shutdown has ended and
we're going to start to get regular data prints again, we think
the data are going to show that job creation has been below
50,000 per month on average, and maybe even a few of them are
going to get to be negative over the next several months. In that
situation, we think the Fed's going to get more inclination to
guard against further deterioration in the labor market by
keeping cutting rates and making sure that the central bank is
not putting any restraint on the economy.
That's similar, I would say, to a lot of other developed markets’
central banks. But the tension for the ECB, for example, is that
President Lagarde has said she thinks; she thinks the
disinflationary process is over. She thinks sitting at 2 percent
for the policy rate, which the ECB thinks of as neutral, then
that's the right place for them to be.
Our take though is that the data are going to push them in a
different direction. We think there is clearly growth in Europe,
but we think it's tepid. And as a result, the disinflationary
process has really still got some more room to run and that
inflation will undershoot their 2 percent target, and as a
result, the ECB is probably going to cut again. And in our view,
down to about 1.5 percent.
Big difference is in Japan. Japan is the developed market central
bank that's hiking. Now, when does that happen? Our best guess is
next month in December at the policy meeting. We've seen this
shift towards reflation. It hasn't been smooth, hasn't been
perfectly linear. But the BoJ looks like they're set to raise
rates again in December. But the path for inflation is going to
be a bit rocky, and so, they're probably on hold for most of
2026. But we do think eventually, maybe not till 2027, they get
back to hiking again – so that Governor Ueda can get the policy
rate back close to neutral before he steps down.
Serena Tang: So, one of the main investor
debates is on AI. Whether it's CapEx, productivity, the future of
work. How is that factoring into your team's view on growth and
inflation for the next year?
Seth Carpenter: Yeah, I mean that is
absolutely a key question that we get all the time from investors
around the world. When I think about AI and how it's affecting
the economy, I think about the demand side of the economy, and
that's where you think about this CapEx spending – building data
centers, buying semiconductors, that sort of thing. That's demand
in the economy. It's using up current resources in the economy,
and it's got to be somewhat inflationary. It's part of what has
kept the U.S. economy buoyant and resilient this year – is that
CapEx spending.
Now you also mentioned productivity, and for me, that's on the
supply side of the economy. That's after the technology is in
place. After firms have started to adopt the technology, they're
able to produce either the same amount with fewer workers, or
they're able to produce more with the same amount of workers.
Either way, that's what productivity means, and it's on the
supply side. It can mean faster growth and less inflation.
I think where we are for 2026, and it's important that we focus
it on the near term, is the demand side is much more important
than the supply side. So, we think growth continues. It's
supported by this business investment spending. But we still
think inflation ends 2026, notably above the Fed's inflation
target. And it's going to make five, five and a half years that
we've been above target. Productivity should kick in. And we've
written down something close to a quarter percentage point of
extra productivity growth for 2026, but not enough to really be
super disinflationary. We think that builds over time, probably
takes a couple of years.
And for example, if we think about some of the announcements
about these data centers that are being built, where they're
really going to unleash the potential of AI, those aren't going
to be completed for a couple of years anyway. So, I think for
now, AI is dominating the demand side of the economy. Over the
next few years, it's going to be a real boost to the supply side
of the economy.
Serena Tang: So that makes a lot of sense
to me, Seth. But can you put those into numbers?
Seth Carpenter: Sure, Serena totally. In
numbers, that's about 3 percent growth. A little bit more than
that for global GDP growth on like a Q4-over-Q4 basis. But for
the U.S. in particular, we've got about 1.75 percent. So that's
not appreciably different from what we're looking for this year
in 2025.
But the number really, kind of, masks the evolution over time. We
think the front part of the year is going to be much weaker. And
only once we get into the second half of next year will things
start to pick up. That said, compared to where we were when we
did the midyear outlook, it's actually a notable upgrade. We've
taken real signal from the fact that business spending, household
spending have both been stronger than we think. And we've tried
to add in just a little bit more in terms of productivity growth
from AI. Layer on top of that, the Fed who's been clearly willing
to start to ease interest rates sooner than we thought at the
time of the mid-year outlook – all comes together for a little
bit better outlook for growth for 2026 in the U.S.
Serena Tang: Seth thanks so much for taking
the time to talk.
Seth Carpenter: Serena, it is always my
pleasure to get to talk to you.
Serena Tang: And thanks for listening.
Please be sure to tune into the second half of our conversation
tomorrow to hear how we're thinking about investment strategy in
the year ahead. If you enjoy Thoughts on the Market, please leave
us a review wherever you listen and share the podcast with a
friend or colleague today.
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