One Global Shock, Different Rate Paths

Chetan Ahya · Morgan Stanley

BOJ will hike only twice, December and March, below the three hikes markets price.

Ahya's house view is that the BOJ hikes twice, in December and again in March next year, against market pricing of three more hikes. The dovish call rests on the source of Japan's inflation. Inflation has been driven mainly by yen weakness and higher commodity prices rather than demand, and real consumption is still about 1% below pre-COVID levels. With no demand-driven overheating, the BOJ will avoid more aggressive tightening.

“We expect the BOJ to hike its policy rate twice first in December and then again in March next year. This compares with market pricing of three more rate hikes. ...Hence, we think BOJ will avoid taking up more aggressive policy tightening.”at 4:41

Jens Eisenschmidt · Morgan Stanley

ECB will tighten gradually; market prices too many hikes, with one in December and possibly March.

The ECB was the only major central bank to get inflation back to target and had already cut rates to 2%, which is roughly neutral. Responding to the energy supply shock is therefore easy: it can tighten by moving toward the restrictive end of the neutral range. The policy question is how strong the economy holds up, since that determines how much of today's inflation becomes tomorrow's through wage agreements. Hikes will be gradual rather than aggressive, and since the last call the risks to inflation have stacked up to the upside, with more inflation and resiliency than expected. Eisenschmidt expects one hike in December and says one more in March is possible. Financial tightening at the long end is a restraint that could mean the ECB ends up right without changing its call. He thinks the market is pricing too many hikes. He contrasts the ECB with the Bank of England, which had been restrictive for longer and had more room to wait.

“I think the market is pricing too many rate hikes. We have one more at this stage in December, and that's it. ...we have seen the tightening at the long end. If that continues, we may very well end up being right with that call without any need to change it.”at 8:20

Chetan Ahya · Morgan Stanley

Most Asian central banks will hike countercyclically as exports drive growth and US rates rise.

Asia does not have a large inflation problem, but growth is strong because of exports. Core inflation is within most central banks' comfort zones, except in Australia and Korea, so they are not expected to react to inflation directly. As US rates rise and growth stays strong, most Asian central banks will take countercyclical rate hikes in the coming quarters.

“...for most central banks, [we are] expecting them to take up rate hikes. But those will be more counter cyclical in nature. ...most central banks will take up countercyclical rate hikes in the coming quarters.”at 9:46

Michael Gapen · Morgan Stanley

Fed tightening is a recalibration against energy second-round effects, adding about 75bp by March.

The Fed is tightening because inflation is persistent and officials are dissatisfied with the pace of convergence to target. The Fed cannot offset the oil shock, so it is leaning against second-round effects from energy prices, which makes this a recalibration rather than a meaningful tightening of policy. Inflation is gradually moving lower and long-run inflation expectations are stable. Financial conditions are already moderately restrictive after the rise in long-end yields and wider credit spreads, and there is little evidence of an overheating labor market. Unless AI spending broadens into labor demand and higher wages, the Fed does not have much more work to do. Gapen expects two more hikes, about 75bp in total, by March next year.

“The way I look at it is this is a story about persistent inflation, and I would look at it as a recalibration of policy. ...it appears to me to be more about a recalibration than it is about meaningfully tightening policy and leaning into demand.”at 1:08

Chetan Ahya · Morgan Stanley

Japan's inflation comes from yen weakness and commodities, not demand, as consumption lags.

Japan's inflation has been driven largely by FX weakness and higher commodity prices rather than by demand-side pressure. The evidence is that real consumption is still about 1% below pre-COVID levels, so the economy is not overheating. This is why Ahya thinks the BOJ will not need aggressive tightening.

“we think that Japan's inflation has been largely driven by FX weakness and higher commodity prices and not due to demand side pressures. ...real consumption is still 1% below pre COVID levels.”at 4:53

Michael Gapen · Morgan Stanley

Energy shock is starting to pass through into US core goods prices such as airfares and cars.

Second-round effects from the energy price shock should show up in airfares, apparel, new and used cars, and motor vehicles and parts. The September inflation report showed these other goods prices were firm, which Gapen treats as an early sign of energy pass-through into other parts of core inflation. He says the next readings will show whether the pattern continues.

“And here, I think that would show up in airfares, apparel, new and used cars, motor vehicles, and parts. ...this is an early sign of energy pass through into other parts of CORE.”at 6:33