The Calm Before the Storm?

Summary

Thoughts on the Market: The Calm Before the Storm?

Hosted by Morgan Stanley
Release Date: December 17, 2024

Morgan Stanley's podcast, Thoughts on the Market, features Seth Carpenter, the firm's Global Chief Economist, who delves into the current state of global financial markets with a focus on central bank activities as the year draws to a close. In the episode titled "The Calm Before the Storm?" released on December 17, 2024, Carpenter provides a comprehensive analysis of recent central bank decisions, upcoming expectations, and the broader economic landscape. This summary encapsulates the key points, discussions, insights, and conclusions presented in the episode.

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1. Year-End Central Bank Outlook

As the year concludes, Carpenter observes a surprising level of certainty surrounding the actions of major central banks. Unlike the unpredictability that marked much of the past year, the final weeks are characterized by clearer expectations regarding monetary policy adjustments.

"Unlike the rest of this past year, year end seems to have a lot more certainty about the last few central bank meetings." (00:00)

This perceived stability is attributed to a consensus among economists and market participants about imminent rate changes, suggesting a temporary period of calm before potential volatility in the new year.

2. European Central Bank (ECB) Actions and Strategy

The ECB recently implemented a 25 basis point (bps) interest rate cut, aligning precisely with both Morgan Stanley's predictions and market expectations. Carpenter delves into the rationale behind this decision and the ECB's future trajectory.

"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." (00:00)

Carpenter highlights that the ECB's move was primarily driven by diminished concerns over disinflation and a heightened focus on downside growth risks. With restrictive monetary policies appearing less necessary, the ECB is transitioning towards easing measures until reaching a neutral stance.

"President Lagarde's statement seems to reflect the Council's negotiated stance that easing will continue until the ECB reaches neutral." (00:00)

Looking forward, Morgan Stanley anticipates that the ECB will continue to reduce rates beyond the neutral level, potentially bringing them down to 1%, signaling a more aggressive approach to stimulate the economy.

"The ECB will come to see there's a need to cut through neutral and get all the way down to 1%." (00:00)

3. Federal Reserve (Fed) Expectations and Inflation Dynamics

The podcast addresses the Federal Reserve's anticipated 25 bps rate cut, a move that aligns with both Morgan Stanley's outlook and market sentiment. Carpenter discusses the factors influencing this decision, particularly the dynamics of inflation and economic growth.

"We expect the fed to cut 25 basis points this week and the market seems to be all in there as well." (00:00)

Carpenter notes that recent employment data suggests a low risk of recession, yet there's ongoing debate within the Fed about the persistence of inflation. Some committee members express concerns that inflation remains stubbornly high, potentially stalling the disinflation process.

"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." (00:00)

Despite these concerns, Morgan Stanley remains optimistic, pointing to recent Consumer Price Index (CPI) data that indicate continued disinflation. This supports the likelihood of the Fed proceeding with the planned rate cut and possibly considering additional cuts in January if the trend persists.

"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." (00:00)

However, Carpenter cautions that future data could challenge the baseline view of rate cuts in March and May, especially if there's a reversal in the disinflationary trend due to factors like residual seasonality or new tariffs.

"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." (00:00)

Chair Powell's upcoming press conference is highlighted as a pivotal moment to gauge the Fed's cautiousness regarding future rate adjustments.

"Chair Powell's remarks at next week's press conference really going to be critical to see if they really are becoming more cautious about cuts." (00:00)

4. Bank of England (BoE) Monetary Policy

Turning to the Bank of England, Carpenter outlines expectations for the UK's central bank, anticipating that rate adjustments will be deferred until the new year. Recent market movements suggest a shift away from a December rate hike towards a more likely increase in January.

"We don't expect the bank of England or the bank of Japan to move until next year." (00:00)

The BoE is expected to resume rate cuts in February, followed by gradual decreases thereafter. Despite elevated services inflation remaining a concern through the year-end, Morgan Stanley forecasts mounting evidence of labor market weakness and decelerating wage growth, which will drive the Monetary Policy Committee (MPC) toward further easing.

"We expect those cuts to come at alternating meetings, December on pause, a cut in February and gradual rate cuts thereafter." (00:00)

However, the recent announcement of fiscal stimulus in the UK introduces potential inflationary risks, albeit at the margin, which could influence the BoE's future policy decisions.

"The recent announcement of fiscal stimulus in the UK starts to raise some inflationary risks at the margin." (00:00)

5. Bank of Japan (BoJ) Rate Hike Prospects

The Bank of Japan is another focal point, with recent currency weakness suggesting the possibility of a rate hike as early as December. Nevertheless, Morgan Stanley maintains that a January rate increase is more plausible, allowing the BoJ to better assess wage negotiations and their impact on future inflation.

"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." (00:00)

Scheduled communications from the BoJ, including Deputy Governor Himono's speech on January 14th, are expected to provide further insights into the central bank's stance, aligning with Morgan Stanley's January hike prediction.

"All of that says the stars are lined up for a January rate hike." (00:00)

Market pricing over recent weeks has shifted away from a December hike towards a January adjustment, reflecting increased confidence in Morgan Stanley's forecast.

"Market pricing over the past couple weeks have moved against a hike in December and towards our call for a hike in January." (00:00)

6. Global Economic Landscape and Future Outlook

Carpenter reflects on the tumultuous year, marked by global elections, shifting central bank expectations, and significant economic transformations, particularly in Japan, which is moving away from decades of nominal stagnation.

"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." (00:00)

Looking ahead to 2025, Carpenter suggests that the economic roller coaster is far from over, anticipating continued volatility and uncertainty in global markets.

"An early glimpse into 2025 suggests that the roller coaster is not over yet." (00:00)

7. Conclusion: A Brief Respite Amidst Uncertainty

Despite the potential for increased volatility in the near future, the current period is expected to offer limited drama from central banks, providing investors and market participants with a temporary period of stability before the new year's anticipated shifts.

"But for now let's take some respite because there should be limited drama from central banks this week. Happy Holidays." (00:00)

Carpenter wraps up the episode by acknowledging the year's challenges and expressing cautious optimism about navigating the coming months.

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Key Takeaways:

• ECB: Implemented a 25 bps rate cut; expected to further reduce rates to 1%.
• Fed: Anticipated to cut rates by 25 bps in December, with possible additional cuts in January based on disinflation trends.
• BoE: Rate hikes on pause until the new year, with gradual cuts expected starting February.
• BoJ: Likely to hike rates in January 2025, influenced by wage negotiations and inflation outlook.
• Global Outlook: Continued economic uncertainty and potential for volatility in 2025, despite a current period of central bank stability.

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Morgan Stanley's Seth Carpenter provides a nuanced and insightful analysis of the current central bank landscape, offering valuable perspectives for investors and stakeholders navigating the end-of-year economic environment. As central banks position themselves for the new year, the coming months will be critical in shaping the direction of global markets.

Transcript

[A]

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 10am 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 the 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 starting to look less and less necessary. And President Lagarde's statement seems to reflect 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 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 Himono 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 footage 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 share thoughts on the market with a friend or colle link today.

[B]

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