With the US Federal Reserve deciding to keep interest rates unchanged for the second time in a row, Chetan Ahya, chief economist at Morgan Stanley, Asia, now anticipates the lag effect of monetary tightening to restrict global growth in the next 18 months. Weak momentum in China and restricted growth in the US and Europe will be the major triggers behind this, he says.
In an exclusive conversation with Moneycontrol, Ahya also spoke about bond yields, China’s economic woes, and commodity price outlooks. Here is the second part of the interview.
Also read: India among best places in emerging markets, macro economy stable: Chetan Ahya of Morgan Stanley
What is Morgan Stanley’s house view on Fed’s decision? When do we start to see rate cuts?
We have been forecasting that the Fed is not going to take up any more rate hikes. This has been largely in line with our expectations. From the market perspective, it was a bit more of a dovish outcome than what the markets were building for.
At this point, we think that the first rate cut could come after around six months. The key metric that we think that the Fed is watching is the unemployment rate and monthly jobs addition. Currently, the inflation outlook has pretty much come in line with what the Fed wants to see.
If you look at the core personal consumption expenditure (PCE) inflation metric on a sequential basis, it's running between 2 and 2.5 percent, which is a comfortable range for the Fed. But if the unemployment rate is so low, and if the Fed tries to sound dovish, and ease financial conditions meaningfully, that will revive growth rates higher than the underlying potential growth, and therefore take wage growth higher and bring back the inflation risks for the Fed.
So now, at this point of time, we think that the jobs data point is the most important one, and it will probably take a few months for the Fed to see those kinds of job drops for them to think about cutting rates.
Do you have a forecast for bond yields for the end of the year?
We are expecting bond yields to go down towards the end of the year. More meaningfully, they should decline in the first half of next year. But that is predicated on the view that I mentioned earlier on the Fed’s path, and to the extent to which the Fed is going to hold on to these high levels of interest rates in the next six months. The decline in bond yields will be more gradual, and we don't expect a big decline in bond yields in the next few months.
Also read: Morgan Stanley upgrades India to overweight, downgrades China
Why is China struggling to get back growth?
China is right now facing a significant amount of structural challenges. Those challenges are overwhelming the cyclical outlook for China. What are those challenges?
There is the challenge of debt demographics and deflation, which we characterise as the 3D problem that China faces. That implies that China is currently recording just about 3.5 percent on a nominal GDP growth basis.
The fourth-quarter real GDP growth was 4.9 percent. But that was offset by the fact that the GDP deflator was in deflation, at -1.4 percent. Even though real GDP growth was at 4.9 percent, when you look at the two-year average number, it's running closer to 4 percent.
That has been the main issue with China, when it was growing before COVID, at 6.5 percent, with the GDP deflator being in deflation, in addition, nominal GDP growth outcomes are even weaker.
Now, the challenge is that China has been keeping the investment-to-GDP ratio too high in 2023. Investment to GDP is at 40 percent. In the last three years, we've seen that China's total population has also started to decline. So, with the demographics in a position like that, if the policymakers continue to keep investment-to-GDP ratio high, they are seeing the outcome of that in the form of lower capital productivity, or what we economists call the incremental capital-output ratio, deteriorating. On the other side of that is non-performing loans in the banking system. So, when your returns are deteriorating, your non-performing loans will be a big challenge. That is forcing to deleverage the economy, and adding to the downside pressure on the economy.
Will China be able to pick up in the next 1-3 years?
So, in the next 12 months, we do expect them to take up both coordinated fiscal and monetary easing to support the recovery. Having said that, they are still looking to reflate through the old sources of growth, which is property and infrastructure. These are the two areas in which they have had the problem of misallocation.
So, there is a limitation of how much they can reflate in these two areas and revive growth rates needs to be seen. Next year, we expect the underlying growth rate to go up to 4.2 percent. So, it's only a modest recovery that we will see in China, because they are facing these structural challenges which are going to constrain their ability to reflate the economy.
What does this mean for global growth?
China is an important player in the global economy, and, so, because of the weaker growth in China, we are expecting global growth in the range of 2.8 and 2.9 percent in the next 1-3 years. This is much lower than the 30-year average of around three-and-a half percent. So, global growth will be below trend.
While China is weak, we are expecting growth in the US and Europe to be constrained. The trailing numbers in the US are good. But going forward, we see that as the lag effect of the policy tightening which the US is taking up comes through, GDP growth will slow towards the 1.5 to 2% range from the last quarter of 2.9% on a year-on-year basis. As the Developed Markets (DMs) are constrained because of past problems of inflation, and China being somewhat softer, global growth will remain below trend in the next 18 months.
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How does this affect commodity prices?
Let me break the commodities group into three buckets -- oil, food, and non-oil and non-food commodities.
As far as oil is concerned, our commodity strategist is expecting that oil prices will average around $95/bbl in the fourth quarter. Next year onwards, it will start to go down. By the end of 2024, it will be at about $85. So, it will be slightly higher in the near term and then it will go down gradually throughout 2024.
As far as other commodities are concerned, for non-oil, non-food commodities, we think there will be a modest upside to select products like copper and aluminum. For nickel and cobalt, we see some downside, but more or less, the non-oil commodity prices also will remain range-bound.
Food prices are a bit harder to forecast as they are affected by what happens to the crop outlook and the impact of El Nino. But at this point of time, we are not seeing a big rise in food prices, which is becoming a challenge from an inflation perspective for emerging markets like India.
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