The Beyoncé Effect
By Seth Carpenter, Morgan Stanley global chief economist
Under the heading of “this time is different,” Swedish inflation made global headlines. Beyoncé’s global tour started in Stockholm last month, and hotel and restaurant prices drove a notable upside surprise to Swedish CPI (well, an upside surprise to markets, less of a surprise to our resident member of the Beyhive). Why talk about the pop star in a week dominated by central banks? Even if this inflation proves to be, dare I say it, transitory, it demonstrates how much residual pent-up Covid demand there can be, especially in services, and how it can show up where you least expect it.
Markets have been searching for the peak rate of the hiking cycles and anticipating a pivot to easing. A funny thing happened along the way. The conversation is now about skips and pauses. Investors are learning that central banks can restart hiking cycles after stopping.
The Reserve Bank of Australia and markets had prepared for a pause after the March hike. But at its May meeting, the RBA surprised markets by hiking another 25bp. A further hike at the June meeting underscored that pauses are only as good as the data flow. Speaking at the Morgan Stanley Australia Summit after the June policy meeting, the RBA governor pointed to a sudden change in financial conditions, resilient household spending, inflation expectations, and rising unit labor costs as driving further hikes.
In January, the Bank of Canada had said it would take a “conditional pause” from hiking to assess the economy. Both economic activity and inflation proved stronger than expected in January, and at its June meeting the BoC surprised markets by resuming its hiking cycle. The BoC had concluded that monetary policy “was not sufficiently restrictive.”
As the Fed met this week, the market was pricing in a “skip.” The Fed did not hike, but its “dot plot” pointed to two more hikes this year. Should a skip be the base case? Well, Chair Powell corrected himself for using the word “skip.” But the lesson from the RBA and the BoC is not that we should expect a resumption of hikes, but rather that we should not be surprised if hikes resume when data do not cooperate. The Beyoncé effect should keep us from getting too complacent.
Our US team forecasts notable further deceleration for both payrolls and inflation before the July meeting. If our forecast for CPI is realized, the Fed’s forecast for inflation will have to get revised down, and Chair Powell’s insistence that the “July meeting will be live” will likely be rendered moot. A resumption of hikes, therefore, is simply not our base case. But I will repeat a point I have made in the past. The Fed might be done now only to resume hikes much later. Recall that in 1996, after a very slight reversal of a similarly rapid hiking cycle, the Fed held policy constant for a year, only to have the next policy move be a hike.
The situation is somewhat different in the euro area. Inflation remains high, and the inflation forecasts at last week’s meeting supported President Lagarde’s indication of another hike. But we think the last inflation print marked a fairly decisive downward trend in core inflation. By the time the ECB stops hiking, we think that trend will be clear, in contrast to the Fed, where the current inflection point presents two-way risk.
