Certainly, let’s reshape this in a manner that perhaps an Englishman might express himself:
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Seth Carpenter: Welcome to Thoughts on the Market. I’m Seth Carpenter, Morgan Stanley’s Global Chief Economist and Head of Macro Research. Today, we’re embarking on our quarterly economic roundtable for the year. We’ll attempt to touch upon everything significant in world economics. Our initial focus today is on central banking. Tomorrow, we’ll delve into the nitty-gritty of the real economy.
I’m accompanied by our esteemed regional economists.
Michael Gapen: Greetings, Seth. I’m Mike Gapen, Chief U.S. Economist at Morgan Stanley.
Chetan Ahya: I’m Chetan Ahya, Chief Asia Economist.
Jens Eisenschmidt: And I’m Jens Eisenschmidt, Chief Europe Economist.
Seth Carpenter: It’s Thursday, January 22nd at 10 am in New York.
Jens Eisenschmidt: And 4 pm in Frankfurt.
Chetan Ahya: And 9 pm in Hong Kong.
Seth Carpenter: Mike Gapen, as we venture into 2026, what are our thoughts? Are we moving towards a more stable expansion, or is this merely another phase with similar volatility? What do you foresee for the U.S.? If we err, which way might that be?
Michael Gapen: Indeed, Seth, we initially believed we would witness more policy certainty. Recent developments suggest we might have been mistaken on that front. Nonetheless, regarding deregulation, immigration, and fiscal policy, we possess much more clarity than a year ago. I anticipate another year of modest growth, above trend growth. We’re forecasting around 2.4% for 2026, akin to the close of 2025. The pivotal aspect for markets will be whether inflation abates. Tariffs are still impacting consumers. We expect it to persist through the first quarter. Subsequently, inflation pressures should ease. If true, the Fed might implement one or two rate cuts in the latter half of the year. Growth seems robust enough, and the labour market has stabilised sufficiently for the Fed to pause and assess the outcomes of prior rate cuts, thus moving policy closer to neutral as inflation abates.
Seth Carpenter: Reflecting on last year, 2025, I’ll commend you initially. Unlike some competitors, Morgan Stanley did not revise its forecast for a U.S. recession. However, and with a touch of jest, we did underestimate U.S. growth. CapEx spending from AI firms was robust, as was consumer spending from the upper income bracket. Overall growth surpassed 2%, nearing 2.5%. Given this, why shouldn’t we expect even stronger growth or perhaps a resurgence in 2026?
Michael Gapen: Some improvement over our forecast was, I believe, due to trade and inventory variability, not necessarily an indicator of enhanced growth. Other outperformances stemmed from the consumer sector, but our models, without delving too much into detail, suggest that consumption exceeds fundamentals. AI spending may also not grow much stronger. Fiscal stimuli offer a slight boost. It’s more of a continuation than an acceleration forward.
Seth Carpenter: Could the Fed refraining from rate cuts be a possibility, contrary to your forecast?
Michael Gapen: Indeed, there’s room for error. We’ve made projections relating to the One Big Beautiful Bill’s economic impact, albeit with some variability. If it spurs more optimism and business spending than anticipated, inflation might not ease significantly. This remains the primary upside risk we’re contemplating. Markets have gradually reduced the likelihood of Fed cuts as growth persistently remains strong, though inflation indicators are positive, suggesting disinflation, we’re still pondering its continuance.
Seth Carpenter: Chetan, in looking to Japan, one might note it’s been the developed market’s central bank outlier—hiking rates whilst others cut. With recent news injecting risk into our year-ahead outlook about both growth and inflation in Japan and the Bank of Japan’s role in normalisation, might you elaborate on our stance on Japan? Presently, the yen and Japanese rates significantly feed into the global market narrative.
Chetan Ahya: Indeed, Seth, on a broader scale, we remain positive on Japan’s macroeconomic outlook. Normal GDP growth retains its strength. We foresee a consumer transition from supply-side inflation, suppressing real wage growth, to a dynamic where real wage growth accelerates. This shift bolsters real consumption growth, pivoting from supply to demand-driven inflation.
However, currency depreciation presents challenges for the BOJ. We expect demand-side pressures to eventually fuel inflation. Nevertheless, recent data predominantly shows currency depreciation and supply-side factors, like food inflation, leading inflation. Consequently, the BOJ remains cautious. Initially anticipating a rate hike by January 2027, there’s risk of earlier action to control the currency and inflation pressures.
Seth Carpenter: Historically, the yen has fluctuated widely. The current weakening hasn’t primarily driven the Bank of Japan’s policy. Rather, it was growth and inflation prompting a departure from negative rates and the zero lower bounds. Indeed, the weaker yen might have appeared advantageous post-25 years of stagnancy in nominal growth. Is the yen’s influence truly reshaping the Bank’s approach?
Chetan Ahya: Your assessment, by and large, is correct, Seth. Yet, there’s a currency threshold beyond which household imported inflation pressures escalate. Despite currency-driven inflation lingering, the BOJ must monitor household inflation expectations closely. Concurrently, the currency depreciation’s broader inflationary impact is significant, as workers demand higher wages influenced by headline inflation. As the regional currency reaches such levels, it compels BOJ intervention.
Seth Carpenter: Moving onto Europe, Jens. The ECB recently concluded a rate-cutting cycle. President Lagarde suggested the disinflationary cycle has concluded. Yet, you’ve noted in your forecasts that further disinflation risks remain for Europe. Could you elaborate on European inflation trends and potential impacts on the European Central Bank? Surely, these aspects are crucial for market participants.
Jens Eisenschmidt: Quite right. We face a critical inflation print due on the 4th of February. This will signal whether our envisaged drop below the ECB’s target materialises. The reasoning is a blend of energy disinflation and base effects. Service inflation, resetting at the year’s start, will also play a role. January and February are pivotal. Notably, wage disinflation is progressing well. Particularly in Germany’s export-oriented manufacturing sector—a key area for national wage setting—disinflationary trends have emerged. This sector is crucial, accounting for 30% of the euro area’s GDP. If confirmed, we foresee ECB cuts in June and September, settling at a terminal rate of 1.5%.
Seth Carpenter: That indeed diverges from the consensus market perspective. In your discussions with global investors, what’s their primary contention regarding your prognosis of the ECB’s actions?
Jens Eisenschmidt: Primarily, two objections arise. One concerns substance: a belief that wages won’t decrease and that the economy will soon overheat due to fiscal stimuli. However, the stimulus is limited to specific regions, constituting 30% of the euro area. Secondly, scepticism of the ECB’s response mechanism exists. Here, perspectives align somewhat; authorities have previously expressed comfort at the 2% rate. Yet, should the economy lower actual inflation below target, evidence will then be essential to justify refraining from additional monetary stimulus. In essence, upcoming inflation prints will likely reshape this dialogue.
Seth Carpenter: That clarifies a great deal, though time eludes us. For now, I express gratitude to Michael, Chetan, Jens for your presence today. And to our listeners, many thanks for joining. Remember, do tune in tomorrow for our conversation’s part two.
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