Morgan Stanley IM: Key Themes for 2023

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The easy money era ended last year as the U.S. Federal Reserve raised rates at the fastest pace since the 1980s to control 40-year high inflation.¹ The COVID-19 pandemic has eased, the Russia-Ukraine conflict has reached a stalemate and the global economy is now adjusting to long-lasting impacts that will usher in new investment themes. Most notably among them are migration trends, a declining U.S. dollar, tighter commodity markets, cracks in the semisphere, a revival in Capex, supply chain resiliency and new leadership in economies and markets. In this paper, we roll out our key themes for the year that will likely have major economic, political and market implications.

1. Prolonged Economic Adjustment
The U.S. has experienced its highest inflation in 40 years and the fastest pace of interest rate hikes since Paul Volcker’s crusade against rising prices in the 1970s. The percentage of economic forecasters expecting negative growth in 2023 is the highest it has been in the last 50 years at 44%, as the impact of the lagged monetary tightening is felt across the economy.² Wall Street’s view is shared by Main Street as CEO sentiment hovers near historical lows. The same consensus believes the recession will lead to a fall in inflation, followed by a Fed pivot and a cut in rates that will propel a growth pickup and market rally in the second half of the year—the quintessential tale of two halves of a dip followed by a rip. We believe the economic adjustment will be more drawn out rather than a V-shaped recovery.

Structural pressures in the labor market, such as a declining workforce, falling immigration and employer incentives to retain workers could limit job market declines. It may take a long time for the unemployment rate to climb from 50-year lows.³ Wage growth at 4-5% suggests no sharp adjustment in consumption and may take sometime to fall to levels consistent with the Fed’s 2% inflation objective.⁴

The housing sector will also be slow in adjusting given there are few sellers, and the buyers are stepping back. Sixty percent of the housing stock is owned by the 55+ age group that is less likely to relocate or downsize.⁵ Since many homeowners obtained low interest rate mortgages, there is little incentive for them to sell and buy at a higher mortgage rate. At the same time, higher interest rates have led to a collapse in demand. It will take some time for the housing market price discovery and adjustment to occur.

Although inflation should ease from its recent highs, it could stay higher for longer. The Fed wants to avoid the monetary policy reversals of the 1970s when they tightened on three separate occasions to break the back of inflation, which could be more durable this time given tight labor markets, resource intensive energy decarbonization and less competition due to deglobalization.

¹ MSIM, Bloomberg, FactSet, Haver

² MSIM, Bloomberg, FactSet, Haver.

³ MSIM, Bloomberg, FactSet, Haver.

⁴ JEF Economics.

⁵ MSIM, Federal Reserve Board, National Bureau of Economic Research, Empirical Research Partners, Haver.

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