Recent market volatility has made headlines, but our Global Chief Economist explains why the numbers aren’t as dire as they seem.
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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll be talking about central banks, the Bank of Japan, Federal Reserve, data and how it drove market volatility.
It's Monday, August 12th at 10am in New York.
You know, if life were a Greek tragedy, we might call it foreshadowing. But in reality, it was probably just an unfortunate coincidence. The BOJ's website temporarily went down when the policy announcement came out. As it turns out, expectations for the BOJ and the Fed drove the market last week. Going into the BOJ meeting consensus was for a September hike, but July was clearly in play.
The market's initial reaction to the decision itself was relatively calm; but in the press conference following the decision, Governor Ueda surprised the markets by talking about future hikes. Some hiking was already priced in, and Ueda san's comments pushed the amount priced in up by another, call it 8 basis points, and it increased volatility.
In the aftermath of that market volatility, Deputy Governor Yoshida shifted the narrative again, by stressing that the BOJ was attuned to market conditions and that there was no fundamental change in the BOJ's strategy. But this heightened attention on the BOJ's hiking cycle was a critical backdrop for the US non farm payrolls two days later.
The market knew the BOJ would hike, and knew the Fed would cut, but Ueda san's tone and the downside surprise to payrolls ignited two separate but related market risks: A US growth slowdown and the yen carry trade.
The Fed's July meeting was the same day as the BOJ decision, and Chair Powell guided markets to a September rate cut. Prior to July, the FOMC was much more focused on inflation after the upside surprises in the first quarter. But as inflation softened, the dual mandate came into a finer balance. The shift in focus to both growth and inflation was not missed by markets; and then payrolls at about 114, 000 in July. Well, that was far from disastrous; but because the print was a miss relative to expectations on the heel of a shift in that focus, the market reaction was outsized.
Our baseline view remains a soft landing in the United States; and those details we discussed extensively in our monthly periodical. Now, markets usually trade inflections, but with this cycle, we have tried to stress that you have to look at not just changes, but also the level of the economy. Q2 GDP was at 2.6 per cent. Consumer spending grew at 2.3 per cent. And the three-month average for payrolls was at 170, 000 -- even after the disappointing July print.
Those are not terribly frightening numbers. The unemployment rate at 4.3 per cent is still low for the United States. And 17 basis points of that two-tenths rise last month; well, that was an increase in labor force participation. That's hardly the stuff of a failing labor market.
So, while these data are backward looking, they are far from recessionary. Markets will always be forward looking, of course; but the recent hard data cannot be ignored. We think the economy is on its way to a soft landing, but the market is on alert for any and all signs for more dramatic weakness.
The data just don't indicate any accelerated deterioration in the economy, though. Our FX Strategy colleagues have long said that Fed cuts and BOJ hikes would lead to yen appreciation. But this recent move? It was rapid, to say the least. But if we think about it, the pair really has only come into rough alignment with the Morgan Stanley targets based on just interest rate differentials alone.
We also want to stress the fundamentals here for the Bank of Japan as well. We retain our view for cautious rate hikes by the BOJ with the next one coming in January. That's not anything dramatic because over the whole forecast that means that real rates will stay negative all the way through the end of 2025.
These themes -- the deterioration in the US growth situation and the appreciation of the yen -- they're not going away anytime soon. We're entering a few weeks of sparse US data, though, where second tier indicators like unemployment insurance claims, which are subject to lots of seasonality, and retail sales data, which tend to be volatile month to month and have had less correlation recently with aggregate spending, well, they're going to take center stage in the absence of other harder indicators.
The normalization of inflation and rates in Japan will probably take years, not just months, to sort out. The pace of convergence between the Fed and the BOJ? It's going to continue to ebb and flow. But for now, and despite all the market volatility, we retain our outlook for both economies and both central banks. We see the economic fundamentals still in line with our baseline views.
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