September 23, 2022 04:09 PM GMT
US Economics | North America
Running in Place
Inflation persistence means higher rates are needed to achieve
similar outcomes. We now see an additional 75bp in monetary
tightening to a peak rate of 4.625% in January 2023. Tighter
policy pushes the economy further below its potential next
year, creating the slack needed to reduce inflation.
MORGAN STANLEY & CO. LLC
Ellen Zentner
CHIEF US ECONOMIST
Ellen.Zentner@morganstanley.com
+1 212 296-4882
Julian M Richers
ECONOMIST
Julian.Richers@morganstanley.com
+1 212 761-2305
Sarah A Wolfe
ECONOMIST
Sarah.Wolfe@morganstanley.com
+1 212 761-0857
Lenoy Dujon
ECONOMIST
Lenoy.Dujon@morganstanley.com
+1 212 761-2779
Outside of the immediate interest-sensitive sectors, there has been little
evidence the real economy is responding to the Fed's policy tightening.
Against persistent core inflation pressures, the Fed is on track to continue
tightening at a faster pace than we had originally anticipated. We now
expect a 75bp hike in November, 50bp in December, and 25bp in January
(vs. 50, 25, and 0 previously). Cumulatively, the fed funds rate reaches a
terminal rate of 4.625% in January, and we expect rates to stay on hold at
this level until the first 25bp rate cut in December of 2023.
While inflation has remained resilient, the growth environment has
softened, and the lagged effect of monetary policy on economic activity
points to more slowing ahead. We revise down our 2023 growth forecast
to 0.5% from 1.3% previously, reflecting substantially more drag from
higher interest rates. We also lower our GDP growth forecasts for 2022 to
0.0% (from 0.2% previously), but low 2022 growth mostly reflects
idiosyncratic drags on activity in the first half of this year, while sequential
growth shows a slowing from 2H22 into 1H23. From there on out, a mild
recovery sets in, but growth remains strongly below potential for all of
2023.
Weakness in economic activity will be more broadly spread. The sharper
slowdown in 2023 predominantly reflects a downshift in consumption
growth, following the 2-3 quarter lagged effect of monetary policy
tightening, in particular in interest-sensitive durable goods. Business
investment also tends to respond with a lag and will become a negative
for growth in the first half of 2023.
With growth falling more rapidly below potential, the labor market is on
track to do the same. We now see monthly job gains bottoming at 55k in
the middle of 2023, not negative but substantially below the replacement
rate. Lower job growth in combination with a rising participation rate lifts
the unemployment to 4.4% by the end of 2023 (vs. 4.3% previously). While
the change in our forecasted unemployment rate is relatively small,
participation increases are now responsible for a smaller share of the
increase, a less favorable outcome.
For important disclosures, refer to the Disclosure Section,
located at the end of this report.
1
Inflation pressures have still not decisively turned lower, in particular
because of rising shelter costs. High-frequency measures point to eventual
deceleration, though it should be gradual even as the labor market
loosens on below-potential growth. We see core PCE at 4.6%Y in 4Q22
and 3.1%Y in 4Q23, too high to allow for rate cuts much before the end of
2023.
Risks to the outlook and to the monetary policy path are now to the
downside. Given its lagged effects, there already is a lot of tightening in
the pipeline that still has not yet filtered into the economy, and even more
tightening is on the horizon. The pace of rate increases is also
unprecedented, and with a peak rate of 4.625%, financial conditions may
well move into overtightening territory. We continue to see a path to a
soft landing, but that path has narrowed.
2
Outlook in a Nutshell
Data through August pointed to an acceleration in key components of core inflation.
Inflation persistence and little sign as yet of broad weakening in the economy
necessitate a longer tightening cycle with a higher peak rate. We now expect the policy
rate to reach 4.25%-4.50% by the end of this year, and peak at 4.50%-4.75% in January
2023, 75bp higher than our previous expectation. Tighter policy slows the economy
further below its potential, pushing the unemployment rate higher in order to apply the
same amount of downward pressure on core inflation.
While more restrictive policy is the primary driver of forecast changes in 2023, incoming
data for the back half of 2022 point to a continued growth slowdown. Weighed down
by inventories and net trade, the US economy moved through a technical recession in
the first half of the year, averaging an annualized contraction of 1.1% GDP. We forecast
GDP growth to average an annualized 1.2% in the second half, which puts US GDP
growth at 0.0% 4Q/4Q in 2022. Homing in on the strength of the domestic economy,
we forecast private final domestic demand to expand by 0.6% 4Q/4Q in 2022.
Our 2023 forecast revisions feature the cumulative effects of tighter monetary policy,
as well as a deeper recession in Europe and slowing global demand. We have lowered
our forecast for GDP growth next year to 0.5% 4Q/4Q from 1.3%, previously. Private
final domestic demand performs about in line with headline at 0.4%. While residential
investment remains weak, it is consumption and business investment that are key areas
of aggregate demand that get a downgrade in the outlook. Real PCE slows well below
trend, driven by weaker interest-sensitive durable goods spending, while business
investment begins to contract in 1Q23. A recession in Europe and weaker global growth
lower exports into the end of the year, while imports are expected to slow meaningfully
in 2023 due to weaker consumption.
We expect more weakness in the labor market. We now see job growth decelerating to
its weakest growth point by mid-2023 at 55k/month, below 90k/month, which is our
estimate of the level of net job gains that holds the unemployment rate steady. Weaker
job growth combined with slightly lower participation gains next year, lifts the
unemployment rate from 3.9% in 4Q22 to 4.4% by 4Q23.
Higher rates, weaker growth, and more slack in the labor market are all needed to
achieve similar inflation outcomes we previously forecasted. We continue to expect
core PCE at 4.6% in 4Q22 and at 3.1% in 4Q23. Core services inflation, in particular
shelter, will remain a persistent driver of above-target inflation in the intermediate term,
even as the economy slows.
A policy mistake is in focus. We continue to see a path to a soft landing, but that path
has narrowed. At the Fed’s current pace of tightening, uncertainty as to how the
economy will respond a few months down the line is high. The labor market tends to be
slow-moving, but we (and monetary policymakers) have no experience with interest rate
changes of this magnitude and activity could come to a halt faster than expected. The
higher the peak rate of interest the Fed aims for, the greater the risk of recession. We
3
are already moving through sustained below-potential GDP growth. Now, we need to
see job gains slow materially to take pressure off the pace of policy tightening. We
continue to see a path to a soft landing, but it is an increasingly narrow one.
Mind the revisions: We see upside risks to growth for 2022 when benchmark revisions
for the first half of the year are released on September 29, 2022. The first half of the
year posted two consecutive quarters of negative growth due to volatile inventories and
net exports. Upward revisions through 1Q22 toward the stronger growth in gross
domestic income (GDI) could lift growth to positive for the year.
Exhibit 1 and Exhibit 2 provide a summary table of forecasts as well as detailing 4Q/4Q
GDP growth and the contributions of its major components.
Exhibit 1: Components of GDP: Quarterly and Annual 4Q/4Q Growth Path
(4Q/4Q % Change)
Real GDP
Final Sales
Final Domestic Demand
Final Private Domestic Demand
PCE
Business Fixed Investment
Residential Fixed Investment
Exports
Imports
Government
CPI
Core PCEPI
Unemployment Rate*
2020
-2.3
-2.6
-1.3
-1.8
-2.4
-3.8
15.7
-10.7
0.3
1.2
1.2
1.6
6.8
2021
5.5
4.6
5.3
6.4
6.9
6.6
-1.5
4.9
9.6
0.1
6.7
5.0
4.2
New Forecast
2022
2023
0.0
0.5
0.5
0.9
0.4
0.6
0.6
0.4
1.4
0.9
3.1
-1.4
-17.5
-2.4
6.9
1.9
5.1
-0.4
-1.3
1.8
6.6
2.7
6.0
3.1
3.9
4.4
Source: Bureau of Economic Analysis, Morgan Stanley Research forecasts from 3Q22 onward.
Exhibit 2: Contributions to 4Q/4Q Real GDP Growth Table
Contributions to 4Q/4Q % Change in Real GDP (percentage points)
2020A
2021A
2022E
2023E
PCE
Business Fixed
Investment
Residential
Fixed
Investment
Net Exports
Gov't
Inventories
Real GDP
-1.7%
4.8%
1.0%
0.6%
-0.6%
1.0%
0.5%
-0.2%
0.6%
-0.1%
-0.5%
-0.1%
-1.4%
-1.2%
-0.1%
0.3%
0.2%
-0.1%
-0.2%
0.1%
0.3%
0.5%
-0.2%
-0.4%
-2.3%
5.5%
0.0%
0.5%
Source: Bureau of Economic Analysis, Morgan Stanley Research forecasts from 3Q22 onward.
The Details
Monetary Policy – An Even Steeper Path: Following a fourth consecutive 75bp hike at
the November FOMC meeting, we also see the Fed delivering 50bp in December (up
from 25bp prior) and 25bp in January, reaching a peak level of 4.625% in January, where
we expect the Fed to hold rates until the first cut in December of 2023. In contrast to
before, we now see risks to the new rate path skewed to the downside. In particular, a
faster deterioration in the labor market could lead the Fed to shift down the pace of
tightening or to reach a peak rate earlier than anticipated.
4
The Fed will "keep at it until the job is done," said Chair Powell in the Q&A after the
September FOMC decision. Sharply higher rates are needed to get inflation under
control, and there's no "painless way to do that." While it is easy to get carried away
about how high the peak rate could be in this cycle, the higher the Fed aims – and in
particular at the current speed – the greater the risk of recession. To that end, fed funds
futures continue to point to rate cuts beginning around the middle of 2023, whereas the
median participant on the FOMC sees cuts beginning in 2024, according to the
September Summary of Economic Projections (SEP).
Exhibit 3 provides a roadmap of our data release forecasts through 1Q23, alongside a
subjective view on the Fed’s data-dependent action. The table shows potential
thresholds around the incoming data that could move the extent and pace of the Fed's
tightening path. Between now and the November 1-2 FOMC meeting, inflation data will
be limited to just one more print, not enough to establish a trend, and one retail sales
and employment report. Data in line with our expectation we expect will lead the Fed
to deliver another 75bp rate hike.
Exhibit 3: Roadmap of data releases and Fed reaction
%M
Jul-22
Aug-22
Sep-22
Oct-22
Nov-22
Dec-22
Jan-23
Feb-23
Mar-23
Headline
Headline
Core PCE
PCE
CPI
-0.07
0.08
-0.02
0.28
0.55
0.12
0.03
0.37
-0.19
0.21
0.35
0.13
0.35
0.32
0.40
0.36
0.30
0.42
0.15
0.29
0.05
0.27
0.28
0.27
0.36
0.27
0.43
Core
CPI
0.31
0.57
0.41
0.38
0.34
0.31
0.29
0.27
0.26
Nominal
Consumption
0.04
0.33
0.18
0.27
0.38
0.41
0.23
0.32
0.37
Real
Consumption
0.20
0.17
0.15
0.06
0.03
0.05
0.08
0.05
0.01
NFP
UR
526
315
250
190
160
140
110
100
100
3.5
3.7
3.7
3.8
3.8
3.9
3.9
4.0
4.0
Assessment:
NFP <100 & core CPI<0.3 -- 50bps in November
NFP <0, UR >4, core CPI<0.2 -- 0bp in December / core CPI >0.35 -- 50bps in December
UR >3.8, core CPI<0.3 -- 0bp in Jan// core CPI>0.4 -- 50 bps in January
core CPI>0.4 -- 25 bps in March
Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Morgan Stanley Research forecasts
Looking beyond November, two more inflation prints in hand by the December meeting
should allow the Fed to step down to 50bp, and to 25bp in January before stopping
entirely. Barring a collapse in job growth and a spike in the unemployment rate, we
expect this glidepath for hikes to cumulate in a peak rate of 4.625%, and subsequently, a
period of watchful waiting. While the Fed will look to stop the tightening cycle to assess
its effects on the economy, we would expect FOMC members to emphasize that they
stand ready to reengage if inflation does not remain on a convincing downward trend.
As the downward trend in inflation becomes visibly entrenched and payrolls fall below
the replacement rate, Fed officials will be able to take a more balanced stance around
the next policy move. However, with core PCE inflation above 3% for all of 2023, we do
not see the Fed cutting rates before December 2023, with some risk that the first cut
could come even later. While a weaker labor market could motivate an earlier
deceleration or even a stop to rate hikes in the coming months, inflation will be a
binding constraint for rate cuts. Still, while core inflation above 3% is most likely too
high, the September SEP confirmed our view that FOMC members are perfectly fine
with easing policy even as inflation remains above target.
Based on our new forecasts, the Fed is on track to exceed the extent of the 2005
tightening cycle – and to do so in a third of the time. The pace of monetary tightening
as well as the level of the peak rate point to clear risks of overtightening, as flagged by
Vice Chair Brainard. At the Fed’s current pace of tightening, uncertainty as to how the
economy will respond a few months down the line is high. The labor market tends to be
slow-moving, but we (and monetary policymakers) have no experience with interest rate
changes of this magnitude and activity could come to a halt faster than expected.
5
Exhibit 4 and Exhibit 5 provide a historical look at today's hiking cycle, and illustrates our
expectation for the path of policy vs. the median participant in the September SEP and
fed funds futures.
Exhibit 4: Historical Tightening Cycles
Exhibit 5: FOMC September Dot Plot vs. MSe
Federal Funds Rate, Cumulative Change in FFR from Start to End of Each Hiking Cycle
5
1987
1988
1994
1997
1999
2004
2015
2022 - MS Forecast
4.5
Implied Fed Funds Target Rate, percent EOP
5.0
4.5
4
4.0
3.5
3
3.5
2.5
3.0
2
2.5
1.5
2.0
1
0.5
1.5
0
1.0
0
10
20
Months, 0=Start of Hiking Cycle
30
September FOMC Median
2022
Morgan Stanley
2023
Fed Funds Futures (Sep 22)
2024
Longer Term
Source: Federal Reserve, Morgan Stanley Research forecasts
Source: Federal Reserve, Morgan Stanley Research forecasts
Consumption – The Breaks Start Working: We expect a higher peak rate to lower
consumption more meaningfully in 2023. Since our last forecast, consumption for 2Q22
was stronger than expected, lifting our forecast for real PCE from 1.2% 4Q/4Q growth in
2022 to 1.4% (Exhibit 6). In 2023, however, we have lowered growth 20bp, to 0.9%
4Q/4Q. This is well below the 2%-3% average growth rate for real PCE in the years
preceding Covid. Our models indicate that consumption, in particular durable goods
spending, reacts to policy tightening with a 2-3 quarter lag (Exhibit 7). As such, we
forecast the weakest quarter for consumption will be 1Q23, following the largest delta
in policy tightening across 2Q22 and 3Q22. Consumption remains subdued throughout
2023, as rates stay on hold at 4.625% until December 2023.
Exhibit 6: Income & Spending Path
Exhibit 7: Modelled Impact to Durable Goods Consumption
Modelled Impact on Real Durable Goods Consumption from FFR Shock, %
Quarterly Income & Spending Path, %
6%
7%
Real PCE
Real DPI
Saving Rate (rhs)
5
3.5
4%
2.8
2%
2.3
1.8
1.5
0.9
0.7
0.9
1.0
1.1
5%
Dec-22
Mar-23
Jun-23
Sep-23
Dec-23
4%
0%
Mar-22
Jun-22
-0.6
Sep-22
Total Durable Goods Consumption (% Change from Trend)
4
3
1.9
1.4
1.4
0.5
6%
Federal Funds Rate
2
1
0
-2%
1Q21 2Q21 3Q21 4Q21 1Q22 2Q22 3Q22 4Q22 1Q23 2Q23 3Q23 4Q23 1Q24 2Q24 3Q24 4Q24
3%
-4%
-1
-2
2%
-6%
-3
Source: Bureau of Economic Analysis, Morgan Stanley Research
-8%
1%
-7.8
-10%
0%
Source: Bureau of Economic Analysis, Morgan Stanley Research
We expect the ongoing wallet shift from goods back to services to continue, but not
without volatility. In nominal terms, higher prices for goods vs services is keeping
nominal goods spending elevated and lowering the savings rate. In real terms, we are
6
seeing somewhat more strength in durable goods spending than expected, in particular
among home furnishing and recreational goods/vehicles. We expect the wallet shift to
continue, albeit at a slow pace. The reversion in nominal spending will be partly a result
of goods prices coming down in 2023 due to easing supply chain pressures, while
services inflation remains firm. Further, we expect that services categories that are on an
upward trajectory in real terms still have room to grow (Exhibit 8 & Exhibit 9).
Interest rates will play an increasingly larger role in slowing durable goods spending
next year. However, there are idiosyncratic factors to take into consideration. For
example, motor vehicle spending is a large durable goods category that is sensitive to
changes in interest rates, but with a tremendous shortfall in motor vehicles, it will be
tough to deter demand in the near term – in particular while the labor market continues
to expand. Further, our housing strategists continue to stress that affordability
pressures in housing are keeping people in their homes, in what they call the “lock-in”
effect. This means that instead of buying a new home, folks may decide to spend more
on upgrading what they have via home renovations and furnishing.
Higher rates, on top of a slowing labor market, is why we forecast real PCE growth well
below potential throughout next year. Looking to the end of 2023, we do not expect
services spending to regain its full share but continue to creep up. As we have
highlighted, the full recovery in services spending may yet be years out on the horizon.
Exhibit 8: Wallet Shift
Exhibit 9: Contributions to Nominal PCE Growth
% of Nominal Personal Consumption Expenditures
Nondurable Goods
Durable Goods
Contributions to Y/Y Nominal PCE Growth
14.0%
Services (rhs)
23.5%
70.0%
Services
Nondurable Goods
Durable Goods
12.0%
10.0%
21.5%
69.0%
8.0%
19.5%
68.0%
6.0%
4.0%
17.5%
67.0%
2.0%
15.5%
0.0%
2020A
66.0%
2021A
2022E
2023E
-2.0%
13.5%
-4.0%
65.0%
11.5%
-6.0%
9.5%
3/1/2018
64.0%
9/1/2018
3/1/2019
9/1/2019
3/1/2020
9/1/2020
3/1/2021
9/1/2021
3/1/2022
9/1/2022
3/1/2023
Source: Bureau of Economic Analysis, Morgan Stanley Research
9/1/2023
Source: Bureau of Economic Analysis, Morgan Stanley Research
Investment – Variable Lags: Higher rates most directly affect new investment
decisions, in particular in residential construction and in business structures
investments. The data flow of recent months already points to very strong declines in
response to higher interest rates, and a higher peak rate will worsen the declines. But
the swiftness of the response also means that the bottom should be reached sooner.
Residential investment has been the quickest to respond to higher rates. With rates
forecasted to be higher for longer, we lower our forecast for residential investment
from -10.0% 4Q/4Q in 2022 to -17.5% and from +5.3% in 2023 to -2.4%.
The US housing market continues to deal with “the lock-in effect”(mentioned above) –
low existing inventories and higher interest rates keeping existing homeowners in their
7
current homes, as well as continued affordability deterioration. As a result, the backlog
of homes under construction combined with ongoing affordability pressures should
slow residential investment and housing starts well into 2023. That said, given the size
of the initial decline, the negative growth impulse from residential investment should
shrink quickly into 2023 and turn positive again in 4Q23, as the prospects of monetary
easing and a structural housing supply shortage motivate a recovery in housing starts
off of a low base.
Higher interest rates will also meaningfully lower business investment growth in 2023
as firms face a drastically changed financing environment. We now see business
investment slowing from 3.1% 4Q/4Q growth in 2022 to -1.4% in 2023. The lags for
business investment following rate hikes are typically much longer than those for
consumption. Historically, growth in aggregate business investment troughs roughly
four quarters after consumption, which would place it in 1Q24.
Within business investment, equipment investment is the most sensitive to higher
interest rates and fluctuates the most across the business cycle. Equipment investment
becomes a meaningful drag to growth starting in 1Q23 and does not turn positive for the
remainder of 2023 (Exhibit 10). Equipment investment growth has already declined in
recent months, and our Capex Plans Index also points to deceleration. Business
structures investment is already falling quite rapidly but should flatten out in 2023
(Exhibit 11).
Exhibit 10: Business Investment
Exhibit 11: Capex Plans
Business Investment, Index (4Q19=100)
130
120
110
100
90
80
70
Structures (rhs)
Equipment
60
Jun-19 Nov-19 Apr-20 Sep-20 Feb-21
IPP
Business Investment
Source: BEA, Federal Reserve, Morgan Stanley Research
Jul-21
Dec-21 May-22 Oct-22
Mar-23 Aug-23
Source: Bureau of Economic Analysis, Morgan Stanley Research
Labor – Creating Slack: On the back of slower growth and tighter monetary policy, we
see weak job growth and the unemployment rate continuing to move up through the
end of 2023. Job growth slows sharply in the coming months and falls below the
replacement rate in the first quarter of 2023, reflecting both below-potential growth
and an eventual end to the backfilling of open positions. Job gains have far outpaced
real output gains this year, likely because employers overutilized existing labor
resources in the bounceback from the pandemic. Strong hiring and labor demand
therefore continued even as demand conditions cooled. As some measures of labor
utilization, such as the average hourly work week, have begun to normalize, we would
expect the relationship between job growth and activity to normalize as well over time.
8
Consequently, we see monthly nonfarm payroll gains slowing from an average pace of
443k in 1H22 to 265k in 2H22 and 74k in 2023 (troughing at 55k/month in mid-2023)
(Exhibit 12).
As before, we also expect upward pressure on the unemployment rate from the growth
in participation. Higher wage levels on the one hand and higher cost of living on the
other should drive a rise in the prime age labor participation rate, which is on track to
reconnect with its pre-pandemic trend. Due to adverse demographic trends, total labor
force participation in our forecasts still falls short of its pre-pandemic level by the end
of 2023 at 63.0%, lower than in our previous forecasts due to weaker pull factor from
lower job gains (Exhibit 13).
Given this increase, our forecast predicts the unemployment rate to hit 3.9% at the end
of 2022, followed by a gradual rise to 4.4% by the end of 2023. While this is only 0.1%
above our previous expectation for unemployment, the increase is now less benign,
with weaker job growth playing a larger role, and labor supply expansion playing a
lesser role than before. Still, as labor markets remain relatively tight, wage growth
remains elevated in the near term before slowing next year.
As Fed Chair Powell has made very clear, given the current economic circumstances and
the Fed’s goal of getting inflation under control, the labor market is likely to be greatly
impacted. In the last two quarters as well as in the current quarter, we have seen
surprising strength in the labor market as demand for workers has been much greater
than the supply of workers. The main drivers of such a phenomenon were the decline in
labor force participation – the pandemic induced many early retirements, for example –
and wage growth led by job switchers. Nevertheless, with the Fed's efforts to slow the
economy and get prices under control, we expect to see a shift in the labor market as
firms start to cut back on job openings and freeze hiring, and the labor force
participation increases.
Exhibit 12: We Expect Job Gains to Slow to About 55k Per Month by
Mid-2023
Change in nonfarm payrolls, thousands
800
Actual
Exhibit 13: Participation Picks Up Near Term, but Gains Slow in Line
with Job Growth
85
Labor force participation rate, percent
65
Expected
Prime Age
700
Total (RHS)
84
64
83
63
400
82
62
300
81
61
80
60
79
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
59
600
500
200
100
0
Jan-22
Apr-22
Jul-22
Oct-22
Source: BLS, Morgan Stanley Research forecasts
Jan-23
Apr-23
Jul-23
Oct-23
Source: BLS, Morgan Stanley Research forecasts
The unemployment rate reaches 3.9% the end of 2022 and increases to 4.4% at the
end of 2023 and through 2024 (Exhibit 14). This increase in labor market slack puts
downward pressure on wage growth over time, but we expect wage growth to remain
9
strong in the near term, reflecting a still very elevated quits rate and ample job
opportunities. As a result, we expect the employment cost index for total compensation
to come in at 5.0%Y in 4Q22, before moderating next year to 3.2%Y in 4Q23 (Exhibit
15).
As with the growth path, risks are skewed to the downside. Given the steep increases in
interest rates, both already realized and still ahead, and increasing risks of adverse
external shocks to the US economy, jobs numbers could fall even faster than we
currently anticipate. As the economy slows, the underlying volatility of monthly payroll
prints will also make it quite difficult to discern in the moment if the labor market will
experience a soft or a hard landing.
Exhibit 14: We Expect the Unemployment Rate to Increase to 3.9% at
End of 2022 and 4.4% at End of 2023 and 2024
Exhibit 15: We Expect Wage Growth Will be 5.0%Y in 4Q22 and 3.2%Y
in 4Q23
Employment Cost Index, 4-Quarter Percent Change
Unemployment rate, percent
16
6
14
12
5
10
4
8
3
6
3.9
4
4.4
2
1
2
0
0
2018
2019
2020
Source: BLS, Morgan Stanley Research forecasts
2021
2022
2023
Source: BLS, Morgan Stanley Research forecasts
Inflation – A Long Way Down: Inflation pressures remain firm, largely due to rising
shelter costs. High-frequency measures point to eventual deceleration, in particular in
core goods prices, but it will be a gradual process as it hinges on more meaningful easing
in the labor market. The key components that will help ease inflation are shelter and
new and used vehicle prices, given that each holds substantial weight in core inflation.
Lower job growth, and conversely lower household income growth, should dampen
demand pressures, which should help in the deceleration of inflation pressures, but
uncertainty remains high.
We have previously highlighted that shelter inflation will continue to keep inflation
elevated for some time (Exhibit 16). Both rents and owners' equivalent rent reached
consecutive record highs from May through August. While we do not expect further
acceleration, we expect readings to stay high because the underlying drivers of rent
growth, such as aggregate labor income, have remained strong and because sequential
inflation in rent and OER is highly persistent (Exhibit 17). For sequential price inflation of
the shelter ex-hotels aggregate, the autoregressive coefficent is 0.9 over the last 10
years, indicating that even as inflation pressures recede elsewhere, rental inflation is
likely to decline only very slowly over the coming months. A weaker labor market
should help to bring price pressures down, but the effects will come with some delay,
and in the near term, higher mortgage rates are worsening housing supply shortages.
10
Exhibit 16: Core Services Prices to Continue to Trend Higher
CPI Core Services
125
Index
Exhibit 17: Rent of Shelter Inflation to Peak by End of 2022
CPI Shelter
% YoY
8
120
7
115
6
110
5
105
4
100
65 67 69 71 73
95
43 46 49 52 55 58 61 64 67 70
90
Series2
85
3
2
1
0
Jan-19
Jan-20
Jan-21
Jan-22
Jan-23
Source: BLS, Morgan Stanley Research forecasts
Source: BLS, Morgan Stanley Research forecasts
The rest of core services have slowed on the margin, reflecting a somewhat softer
consumer demand environment. Airfares stand out as a main detractor to core services,
with three months of decline after three months of double-digit gains from March
through May. In aggregate, core services prices should respond to a softer labor market,
but given that we expect wage growth deceleration will be moderate, we see large-scale
relief through this channel will take time.
Core goods inflation has played a major role in driving up inflation pressures in 2021
and again in recent months, but we expect this to slow as well (Exhibit 18).
Overconsumption of goods against the backdrop of extreme supply disruptions have
pushed prices for core goods meaningfully higher. Goods prices are now 16% above their
pre-pandemic level, which suggests ample room for disinflation from the goods side as
supply chains normalize and demand shifts to services.
News flow surrounding retailers' bloated inventories and coming markdowns on
consumer goods have raised expectations that prices should come down soon. But a
decomposition of the price level shift unveils that almost all of the increase in price
levels can be traced back to motor vehicles, and in particular the used vehicle market
(Exhibit 19). Prices for apparel are likely to come down, but the price level is only
marginally above pre-Covid. Furnishings have some room to normalize but also account
only for a small fraction of total price increases.
In contrast, motor vehicles account for the largest share but also face the most
protracted supply picture according to our analysts and likely the largest and most
lasting demand overhang, given that the US has been undersupplied by roughly 5mn
units (one quarter of annual new vehicle sales). While some consumers will likely delay
new purchases as income growth slows, the replacement cycle can only be delayed for
so long, indicating that undersupply may boost demand more lastingly in the motor
vehicle market than in markets for other goods (or, in particular, services). We do see car
prices coming down eventually but core goods inflation is not expected to turn
deflationary before November.
11
A sharper slowdown in consumer demand, especially for durable goods, could provide
downside risk to our forecasts. On the other hand, new supply chain distortions,
possibly related to industrial shutdowns in Europe, could again move core goods prices
higher even against weaker aggregate demand.
Exhibit 18: Core Goods Price Level to Stabilize
Exhibit 19: The Increase in Core Goods Prices Almost Exclusively
Reflects Higher Vehicle Prices
Contribution to Core Goods Price Level (ppts, vs Feb-20)
16
14
Furnishing
12
Apparel
New Vehicles
10
Used Vehicles
8
Other
6
Core Goods CPI
4
2
0
-2
Jan-20
Source: Bureau of Labor Statistics, Morgan Stanley forecasts
Apr-20
Jul-20
Oct-20
Jan-21
Apr-21
Jul-21
Oct-21
Jan-22
Apr-22
Jul-22
Source: Bureau of Labor Statistics, Morgan Stanley Research
While a reversal in energy prices lowered headline inflation meaningfully in July and
August, core inflation is likely to come down over the coming months but at a much
slower pace. We see core PCE at 4.6% in 4Q22 and at 3.1% in 4Q23.
Exhibit 20 details our monthly forecasts for CPI and PCE inflation through 2023.
Exhibit 20: Inflation Forecast Path
Source: BLS, Morgan Stanley Research forecasts
Full Forecast Table
12
Exhibit 21: Full Forecast Table
Full table in excel here.
Note: E= Morgan Stanley estimates; A=Actual; * Annualized percent change from prior period; ** Year over Year is annual average; ^ 4Q/4Q is 4Q average.
Source: Morgan Stanley Research
13
Disclosure Section
The information and opinions in Morgan Stanley Research were prepared by Morgan Stanley & Co. LLC, and/or Morgan Stanley C.T.V.M. S.A., and/or Morgan
Stanley Mexico, Casa de Bolsa, S.A. de C.V., and/or Morgan Stanley Canada Limited. As used in this disclosure section, "Morgan Stanley" includes Morgan
Stanley & Co. LLC, Morgan Stanley C.T.V.M. S.A., Morgan Stanley Mexico, Casa de Bolsa, S.A. de C.V., Morgan Stanley Canada Limited and their affiliates
as necessary.
For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan
Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley
Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA.
For valuation methodology and risks associated with any recommendation, rating or price target referenced in this research report, please contact the Client
Support Team as follows: US/Canada +1 800 303-2495; Hong Kong +852 2848-5999; Latin America +1 718 754-5444 (U.S.); London +44 (0)20-7425-8169;
Singapore +65 6834-6860; Sydney +61 (0)2-9770-1505; Tokyo +81 (0)3-6836-9000. Alternatively you may contact your investment representative or Morgan
Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY 10036 USA.
Global Research Conflict Management Policy
Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at
www.morganstanley.com/institutional/research/conflictpolicies. A Portuguese version of the policy can be found at www.morganstanley.com.br
Important Disclosures
Morgan Stanley is not acting as a municipal advisor and the opinions or views contained herein are not intended to be, and do not constitute, advice within the
meaning of Section 975 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Morgan Stanley Research does not provide individually tailored investment advice. Morgan Stanley Research has been prepared without regard to the
circumstances and objectives of those who receive it. Morgan Stanley recommends that investors independently evaluate particular investments and
strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of an investment or strategy will depend on an investor's
circumstances and objectives. The securities, instruments, or strategies discussed in Morgan Stanley Research may not be suitable for all investors, and
certain investors may not be eligible to purchase or participate in some or all of them. Morgan Stanley Research is not an offer to buy or sell or the solicitation
of an offer to buy or sell any security/instrument or to participate in any particular trading strategy. The value of and income from your investments may vary
because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or
financial conditions of companies or other factors. There may be time limitations on the exercise of options or other rights in securities/instruments
transactions. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be
realized. If provided, and unless otherwise stated, the closing price on the cover page is that of the primary exchange for the subject company's
securities/instruments.
The fixed income research analysts, strategists or economists principally responsible for the preparation of Morgan Stanley Research have received
compensation based upon various factors, including quality, accuracy and value of research, firm profitability or revenues (which include fixed income trading
and capital markets profitability or revenues), client feedback and competitive factors. Fixed Income Research analysts', strategists' or economists'
compensation is not linked to investment banking or capital markets transactions performed by Morgan Stanley or the profitability or revenues of particular
trading desks.
With the exception of information regarding Morgan Stanley, Morgan Stanley Research is based on public information. Morgan Stanley makes every effort to
use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or
information in Morgan Stanley Research change apart from when we intend to discontinue equity research coverage of a subject company. Facts and views
presented in Morgan Stanley Research have not been reviewed by, and may not reflect information known to, professionals in other Morgan Stanley business
areas, including investment banking personnel.
Morgan Stanley may make investment decisions that are inconsistent with the recommendations or views in this report.
To our readers based in Taiwan or trading in Taiwan securities/instruments: Information on securities/instruments that trade in Taiwan is distributed by Morgan
Stanley Taiwan Limited ("MSTL"). Such information is for your reference only. The reader should independently evaluate the investment risks and is solely
responsible for their investment decisions. Morgan Stanley Research may not be distributed to the public media or quoted or used by the public media without
the express written consent of Morgan Stanley. Any non-customer reader within the scope of Article 7-1 of the Taiwan Stock Exchange Recommendation
Regulations accessing and/or receiving Morgan Stanley Research is not permitted to provide Morgan Stanley Research to any third party (including but not
limited to related parties, affiliated companies and any other third parties) or engage in any activities regarding Morgan Stanley Research which may create or
give the appearance of creating a conflict of interest. Information on securities/instruments that do not trade in Taiwan is for informational purposes only and is
not to be construed as a recommendation or a solicitation to trade in such securities/instruments. MSTL may not execute transactions for clients in these
securities/instruments.
Morgan Stanley is not incorporated under PRC law and the research in relation to this report is conducted outside the PRC. Morgan Stanley Research does
not constitute an offer to sell or the solicitation of an offer to buy any securities in the PRC. PRC investors shall have the relevant qualifications to invest in
such securities and shall be responsible for obtaining all relevant approvals, licenses, verifications and/or registrations from the relevant governmental
authorities themselves. Neither this report nor any part of it is intended as, or shall constitute, provision of any consultancy or advisory service of securities
investment as defined under PRC law. Such information is provided for your reference only.
Morgan Stanley Research is disseminated in Brazil by Morgan Stanley C.T.V.M. S.A. located at Av. Brigadeiro Faria Lima, 3600, 6th floor, São Paulo - SP,
Brazil; and is regulated by the Comissão de Valores Mobiliários; in Mexico by Morgan Stanley México, Casa de Bolsa, S.A. de C.V which is regulated by
Comision Nacional Bancaria y de Valores. Paseo de los Tamarindos 90, Torre 1, Col. Bosques de las Lomas Floor 29, 05120 Mexico City; in Japan by
Morgan Stanley MUFG Securities Co., Ltd. and, for Commodities related research reports only, Morgan Stanley Capital Group Japan Co., Ltd; in Hong Kong
by Morgan Stanley Asia Limited (which accepts responsibility for its contents) and by Morgan Stanley Bank Asia Limited; in Singapore by Morgan Stanley
Asia (Singapore) Pte. (Registration number 199206298Z) and/or Morgan Stanley Asia (Singapore) Securities Pte Ltd (Registration number 200008434H),
regulated by the Monetary Authority of Singapore (which accepts legal responsibility for its contents and should be contacted with respect to any matters
arising from, or in connection with, Morgan Stanley Research) and by Morgan Stanley Bank Asia Limited, Singapore Branch (Registration number
T14FC0118J); in Australia to "wholesale clients" within the meaning of the Australian Corporations Act by Morgan Stanley Australia Limited A.B.N. 67 003 734
576, holder of Australian financial services license No. 233742, which accepts responsibility for its contents; in Australia to "wholesale clients" and "retail
clients" within the meaning of the Australian Corporations Act by Morgan Stanley Wealth Management Australia Pty Ltd (A.B.N. 19 009 145 555, holder of
Australian financial services license No. 240813, which accepts responsibility for its contents; in Korea by Morgan Stanley & Co International plc, Seoul
Branch; in India by Morgan Stanley India Company Private Limited; in Vietnam this report is issued by Morgan Stanley Singapore Holdings; in Canada by
Morgan Stanley Canada Limited, which has approved of and takes responsibility for its contents in Canada; in Germany and the European Economic Area
where required by Morgan Stanley Europe S.E., regulated by Bundesanstalt fuer Finanzdienstleistungsaufsicht (BaFin); in Spain by Morgan Stanley, S.V.,
S.A., a Morgan Stanley group company, which is supervised by the Spanish Securities Markets Commission (CNMV) and states that Morgan Stanley
Research has been written and distributed in accordance with the rules of conduct applicable to financial research as established under Spanish regulations;
14
in the United States by Morgan Stanley & Co. LLC, which accepts responsibility for its contents. Morgan Stanley & Co. International plc, authorized by the
Prudential Regulatory Authority and regulated by the Financial Conduct Authority and the Prudential Regulatory Authority, disseminates in the UK research
that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by
any of its affiliates. RMB Morgan Stanley Proprietary Limited is a member of the JSE Limited and A2X (Pty) Ltd. RMB Morgan Stanley Proprietary Limited is a
joint venture owned equally by Morgan Stanley International Holdings Inc. and RMB Investment Advisory (Proprietary) Limited, which is wholly owned by
FirstRand Limited.
The trademarks and service marks contained in Morgan Stanley Research are the property of their respective owners. Third-party data providers make no
warranties or representations relating to the accuracy, completeness, or timeliness of the data they provide and shall not have liability for any damages relating
to such data. The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of MSCI and S&P.
Morgan Stanley Research, or any portion thereof may not be reprinted, sold or redistributed without the written consent of Morgan Stanley.
Indicators and trackers referenced in Morgan Stanley Research may not be used as, or treated as, a benchmark under Regulation EU 2016/1011, or any other
similar framework.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (DIFC Branch), regulated by the Dubai
Financial Services Authority (the DFSA), and is directed at Professional Clients only, as defined by the DFSA. The financial products or financial services to
which this research relates will only be made available to a customer who we are satisfied meets the regulatory criteria to be a Professional Client. A
distribution of the different MS Research ratings or recommendations, in percentage terms for Investments in each sector covered, is available upon request
from your sales representative.
The information in Morgan Stanley Research is being communicated by Morgan Stanley & Co. International plc (QFC Branch), regulated by the Qatar
Financial Centre Regulatory Authority (the QFCRA), and is directed at business customers and market counterparties only and is not intended for Retail
Customers as defined by the QFCRA.
As required by the Capital Markets Board of Turkey, investment information, comments and recommendations stated here, are not within the scope of
investment advisory activity. Investment advisory service is provided exclusively to persons based on their risk and income preferences by the authorized firms.
Comments and recommendations stated here are general in nature. These opinions may not fit to your financial status, risk and return preferences. For this
reason, to make an investment decision by relying solely to this information stated here may not bring about outcomes that fit your expectations.
© 2022 Morgan Stanley
15