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- [00:01]
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 US Economist, Chet Naya, our chief Asia economist and Jens 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.
- [00:26]
Jens Eisenschmidt
New York and 4pm in Frankfurt and.
- [00:29]
Chet Naya
9Pm in Hong Kong.
- [00:32]
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 US what's driving it, what's going to hold it up and where are the risks?
- [00:49]
Michael Gapen
I think the primary thing to remember here is that the upper income consumer drives about 40% 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 onto 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 in 2025. So there is a K shaped economy. I think one of the main risks about the US 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.
- [02:06]
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 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?
- [02:37]
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 and 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's intermediate goods, some of it's 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, maybe a heavy lift, but that's what I think it would take to get there.
- [04:02]
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 weak, as strong or a little bit more complicated?
- [04:21]
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 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 add everything together. I think the outlook is an economy that's accelerating mildly and only towards the end of our projection horizon which is 27, so in say two years hits growth rates that are above potential. Here we're really talking about quarterly increments above 0.3. So we are currently between 01 and 02. So you sort of get the picture of a mildly accelerating economy that goes from 0.15 to 035, say in the span of two years.
- [05:29]
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, driving a resilient European economy?
- [05:48]
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 enough. 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 you get more frictions in global trade, that's not great. So we could even have short term more negative news on GDP than positive ones.
- [07:00]
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?
- [07:38]
Chet Naya
Well, I think the macro backdrop for China we think will still be challenging in 2026, but at the same time 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 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 will see China continuing to gain market share in global goods exports. And that supports the corporate micropositive story.
- [08:47]
Seth Carpenter
We know collectively that exports 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?
- [09:21]
Chet Naya
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 rmb. 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 will 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 90s 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.
- [10:56]
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?
- [11:11]
Chet Naya
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 US 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 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.
- [12:09]
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?
- [12:28]
Michael Gapen
Well, I think that would mean a substantial uptick in productivity growth, maybe closer to 3% like we saw in the tech boom in the 90s. 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 because 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.
- [13:04]
Seth Carpenter
Okay, Jens to you. A lot of discussion in the news about possible additional tariffs from the US on Europe in some of the negotiations. Suppose some of the announcements, 10% tariffs rising to 25% tariffs later, suppose those were actually put in place, what does that mean for European growth?
- [13:23]
Jens Eisenschmidt
So I would say 10% additional terrorists. 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 US side is more likely and that would just increase the downside risk for Europe here from that additional round of trade or tariff uncertainty.
- [14:00]
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?
- [14:18]
Chet Naya
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 policy response perspective where policymakers 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.
- [14:47]
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.
- [15:01]
Narrator
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