Morgan Stanley: These Are The 5 Cs That Will Shape 2018

Morgan Stanley's Chetan Ahya, global co-head of economics, who undeterred by Morgan Stanley's dire credit outlook, is especially optimistic about the coming year, and in today's Sunday Start writes that the bank's key call for 2018 is that "the global cycle will stay stronger for longer" and explains that his constructive view is borne out of the confidence that "five critical factors will evolve in a benign fashion."

Here are the 5 factors that form the basis for and Morgan Stanley's optimistic outlook:

1) Capex cycle: How strong will the recovery be?

 

Over the past four quarters, global investment growth has started to pick up from multi-year lows as the cyclical recovery and global trade strengthened. In our base case, we expect global investment growth to accelerate meaningfully in 2018, which is key to our thesis that global GDP growth will rise further above trend in 2018.

 

As DMs advance further in the cycle, rising capacity utilisation and a pick-up in wage growth would incentivise more capital-deepening. In EMs, stronger consumption growth and steady exports growth would raise capacity utilisation, supporting private capex. With DM central banks lifting real rates in the backdrop, the strength of capex growth will be particularly important at this juncture as higher productivity growth is needed to keep the recovery stronger for longer.

 

2) Core inflation: Picking up but staying below target

 

The current cycle has been unique in a number of ways – one key feature is that wage growth and core inflation have remained relatively muted. While idiosyncratic factors have been a drag more recently, structural factors such as technological change and globalisation have also likely put a cap on underlying price pressures.

 

In 2018, we expect DM core inflation to rise as cyclical factors – in particular tighter labour markets – become more supportive, while the transitory impact of idiosyncratic factors fades gradually. Most notably, our forecasts pencil in an above-consensus acceleration in core inflation in the euro area and Japan starting in 2Q18. At the same time, we don’t see core inflation crossing central bank targets of around 2%Y, as structural factors continue to assert influence and reduce the risk of a major overshoot in underlying inflation. We expect US core PCE to rise to an average 1.7%Y in 4Q18, from an estimated 1.5%Y in 4Q17. Over the same time horizon, we expect core inflation in the euro area to increase to 1.6%Y from 0.9%Y, and in Japan to 1.0%Y from 0.2%Y.

 

3) Central banks: Gradual withdrawal of accommodation

 

DM central banks should move towards less expansionary policies, led by the Fed. We expect the Fed to raise rates by a total of 75bp in 2018, while shrinking its balance sheet as planned. We expect the ECB to end quantitative easing and the BoJ to adjust its JGB 10-year yield target in 3Q18.

 

Despite this, the monetary policy stance should remain accommodative as real rates stay below the natural rate in both the euro area and Japan, while US real rates should rise above the natural rate only in 1Q19. Moreover, the productivity pick-up accompanying stronger investment growth should support the cycle for longer, which will likely help to partly offset the headwinds from gradual central bank tightening in DMs.

 

4) Corporate credit risks in the US: Mind the tail

 

The US is the most advanced in terms of the cycle thus far and hence risks to the global cycle are more likely to emerge from there. Drawing on the lessons from the past two cycles in the US, we think that financial stability risks pose a bigger threat to the continuation of the cycle than price stability risks. In terms of sectors, the non-financial corporate sector seems most exposed to higher interest rates at this point as its leverage increased from the low of 65% of GDP in 2Q12 to 72% in 3Q17.

 

At an aggregate level, the impact from Fed rate hikes on the corporate interest rate coverage ratio is expected to be moderate, as argued by a recent paper by the US Fed. While interest coverage ratios have declined, they remain high by historical standards. However, some of the weaker debtors with high leverage and high interest exposure will likely see a more pronounced impact. Indeed, with the share of BBB rated debt in overall investment grade debt rising significantly from 37% in end-2008 to 50% currently (as highlighted by our US credit strategist Adam Richmond), overall financial conditions may tighten meaningfully as credit spreads widen in the context of rate hikes.

 

5) China: Will the pace of tightening get too aggressive?

 

Policy-makers in China have stepped up their efforts to contain financial risks and improve the quality of growth. There have been increasing instances of comments from senior officials and policy actions on this front. This has raised concerns that the tightening could result into a deeper slowdown in China’s growth akin to the 2013-15 episode.

 

We believe that the pace of tightening will be gradual and that four factors will differentiate the current cycle from the 2013-15 episode: 1) Sustained strength in exports growth; 2) Improvement in consumption supported by better wage growth; 3) A healthier state of inventory in the property market; and 4) Improvement in industrial sector profits supported by cumulative capacity cuts since early 2015. The combination of these factors should help to provide an offset. However, if policy-makers do take up aggressive tightening, the slowdown in growth could be more substantial than we project in our base case.

 

To Sum it All Up

 

In a nutshell, a pick-up in investment growth, a gradual rise in core inflation, steady removal of monetary accommodation, contained financial stability risks in the US and a moderate slowdown in China are our base case assumptions for how the macro cycle will unfold in 2018. However, we will be watchful of how these factors shape up over the course of the year to assess the risks.

 

From a markets perspective, our strategists highlight that there could be a more challenging market backdrop as the year progresses, inflation rises and financial conditions become less supportive. Hence, they see that there will be an opportunity to reduce risk later in 1Q. With regards to positioning, they prefer DM in equities, EM in fixed income and USTs within DM bonds. They remain cautious on US HY, given rich valuations and cycle risks

Ironically, Morgan Stanley forget the 6th, and perhaps most important C: cryptocurrencies.

Comments

Clock Crasher Sun, 12/17/2017 - 20:25 Permalink

The only thing that is going to shape 2018 is fear and greed. 10 years of emergency monetary policy is going to bring ruin to the debt based, rehypothicated, fractionaly reserved, fiat doomsday machine known as globalization.  2018 or 2028 is anyones guess.  

Clock Crasher Sun, 12/17/2017 - 20:37 Permalink

The price of the miners & miners indexes have 10x the volume in 2017 compared to where they were in 2014 and 2015 despite being exactly the same price then as they are now.  Smart money has been building a massive long position all this time while the raiding has demoralized and removed the weak hands.  When the big moves happen in the monetary metals it's taking the fewest people along for the ride.  By low sell high.  I see a formation of black swans emerging from the fog of the black lagoon to storm the shores of the swamp.  

kumquatsunite hooligan2009 Mon, 12/18/2017 - 03:26 Permalink

Let's see, my son would like to get married. He LOSES 25% of his income in taxes Before he sees his check. Then he has taxes on the phone bill, taxes on the cable bill, an Almost TEN PERCENT tax on the car he just bought (Washington State) and taxes on Everything. Course this is to pay for all the out of wedlock babies, especially the ones from the blacks and the mexicans who breed without remorse or wondering about how to support these babies *cause whitey will!$=$=!Then there are all the drug programs, aka junkie vacations! So you have welfarities on drugs with their job programs and their rehab programs and Endless numbers of college educated people PAID by the govt running around to "help" them. End it all. No Affirmative action and No Welfare Programs. You work you eat. You do drugs you die. 

In reply to by hooligan2009

Quivering Lip Sun, 12/17/2017 - 22:15 Permalink

Fuck all this hyperbole and prognostication. I summed it up years ago (I used to be Nakki) and I only need 4 C's.CENTRALIZED CONFISCATION AND CONSOLIDATION THROUGH COUNTERFEITING.If or When THE Western CB stops printing look out below. If they dont the everything bubble gets larger. Everything else is bullshit.

Yen Cross Sun, 12/17/2017 - 21:50 Permalink

  Capex?!?! Rolling on the floor with the cockroaches. First of all , any corporate tax savings are going to be used as payoffs, and graft.  Growth is based on demand, which in turn, drives prices higher.  Have all of you forgotten about the [labor participation rate?]   My name is Uncle Sam, and I conjure growth out of thin AIR.    Growth based on bullshit? Seriously!  This all about NOTHING, based on retarded morons that have NEVER seen rates above ZERO in their entire lives.

misnomer00 Mon, 12/18/2017 - 06:57 Permalink

Posting here because I couldn't find the article about how Narendra Modis home state in India elected his party again even after 22 years of same party rule. i thought demonetization and Gst implementation would be a death blow to Modi given all those articles on ZH.