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Why Morgan Stanley Sees US Economy Avoiding Recession

By May 12, 2022No Comments

Economist Robert Rosener tells bank treasurers that rising wages supporting consumption and continued capex by corporates should keep GDP growth above trend.

Not everyone thinks the Fed will push the US economy into recession as it raises rates to fight inflation. Robert Rosener, senior US economist at Morgan Stanley, recently told members of NeuGroup for Regional Bank Treasurers that the firm sees just a 25% chance of recession over the next year.

  • “Avoiding recession is our base case, but markets will have to confront the rising probability of one regardless,” he said in a follow-up email with NeuGroup Insights.

Reasons for guarded optimism. Morgan Stanley expects the US economy to grow 2% this year and 2.1% in 2023, Mr. Rosener said. One factor supporting this view is the longest stretch of such strong job growth on record—including another 428,000 new jobs in April—that has increased aggregate real wage and salary growth, despite inflation weighing on households’ real wages.

  • It helps that consumer balance sheets remain strong, if uneven, and around 90% of the household debt is fixed-rate and unaffected by higher rates.
  • Other factors, Mr. Rosener said, include continued capital expenditures by corporates and their efforts to rebuild pandemic-depleted inventories.
  • Annualized real GDP growth unexpectedly contracted by 1.4% in the first quarter. However, stripping out “noisier” components such as weak exports and the pullback in government spending reveals a more solid 3.7% growth rate, he said.
  • While slowing over the course of this year, Morgan Stanley expects that real GDP growth will remain above trend, with continued strong wage and job growth supporting consumption together with some lift from fiscal policy as infrastructure spending kicks into higher gear from the fourth quarter of 2022 onward.

What to watch. Responding to a member asking what would indicate persistent inflation as the year progresses, Mr. Rosener said Morgan Stanley sees Q1’s very high inflation run rate ebbing to between 4% and 5% for the year, still near double the Fed’s target (see chart). If the Fed’s front-loading rate hikes don’t tap down demand fueling inflation—the hoped for soft landing scenario—more aggressive tightening may be necessary.

  • The biggest risk right now, Mr. Rosener said, stems from supply chains, for which improvement has paused due to China’s Covid-related shutdowns.
    • Inflation forecasts now depend heavily on whether goods prices return to pre-Covid levels and remain persistently elevated, he said, noting that after rising 50% over 2020 and 2021, used car prices fell more than 3% in March but have since flattened and even increased.
  • Rising energy prices prompted by Russia’s invasion of Ukraine could result in yet another wave of inflation, hardening expectations of persistent inflation and prompting rate hikes sufficient to create “slack” in the economy by increasing unemployment.
  • But, Mr. Rosener said, unemployment has never risen more than 50 basis points without a recession following.
  • The most recent data on inflation for the month of April showed little sign of cooling inflationary pressures, Mr. Rosener said this week. “While inflation has likely moved past its peak on a year-over-year basis, the latest data shows that sequential trends remain firm and a plateau may be forming, at least in the near-term, with inflation not far off of its peak and still above 6%,” he said.
    • A slower rate of inflation in pandemic-sensitive categories like airfares, as well as further easing in goods price inflation are two key components that will be needed to get core inflation below that trend over coming months, he added.

Then there’s QT. The Fed is also seeking to shrink its balance sheet by letting Treasury and agency securities it purchased mature—so-called quantitative tightening (QT). How that impacts the slope of the Treasury curve will depend less on QT itself and more how the Treasury Department increases bond issuance to replace that lost funding.

  • That will be the biggest factor in whether the Treasury curve flattens or steepens, Mr. Rosener said, adding Treasury’s current bias toward bills and short-end coupons suggest those may be the biggest issuance segments to offset QT.
    • “That increases our conviction the curve will be flat to slightly inverted by year-end,” he said. Morgan Stanley’s strategists’ latest forecasts see 10-year yields trading around 3.0% through 2H22 and moving sustainably above 3.0% in 1H23 with the 2s10s yield curve inverting again as the Fed hikes rates further.
Justin Jones

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