Inflation could challenge markets next year: Morgan Stanley’s chief economist Chetan Ahya

Inflation could challenge global financial markets in mid-2022, says Morgan Stanley’s chief economist Chetan Ahya. Edited excerpts from an interview:

Which countries in developed markets are taking steps to drive growth? And what role do emerging economies play in promoting global growth?
It’s fairly broadly based in DMs (developed markets). We will see a recovery in both the US and Europe, but the US is oversized in this cycle. It is actually a leader in terms of investments. Within the emerging markets, China is a leader in investment. China’s private investment has always been associated with an improvement in external demand, and we are already seeing it. But we should see that it is broadly based in DMs and EMs. Even some of the major economies in Asia will see improvement in external demand. You should see an improvement in capital spending.

How is the reticent and accommodating attitude of global central banks affecting inflation?
We have indicated that there is a regime change taking place in terms of inflation dynamics during this cycle. Monetary support has been expansive even when we had an aggressive rebound. In the US, for example, we expect GDP to hit the pre-COVID path in the third quarter of this year, and yet the Fed has not yet started to hike rates. A completely different set of guidelines is therefore adopted in DMs. Because they were trying to tackle challenges like income inequality, they faced even before the pandemic. Both the government and the Fed are trying to make the recovery more inclusive and want to be sure that we have the low-income segment on board in terms of job opportunities. We therefore expect higher inflation figures in DM.

The Fed says inflation numbers should be between 2 and 2.5%, but there is a risk that inflation will surprise upside. In this scenario, you may have some challenges in the global financial market, but this risk will occur in mid-2022. During the transition period, the Fed will be able to manage the markets and financial conditions.

What do you think of the current commodities rally and its impact on inflation?
The investment cycle will have a major impact on the demand for raw materials. Capex is going to be the best in the last five cycles we’ve seen. As for the US, it will be the best since 1940. In fact, the US investment cycle looks like it is similar to the post-WWII era. We had a great fiscal expansion during World War II, and we saw a great fiscal expansion in that cycle as well. So this strength of aggregate demand is what is driving investment in the US, and this strength of the investment cycle tells me why you are experiencing this boom in the commodities market.

How do you read the movements on the dollar front?
In the short term, the dollar should remain stable. There are two opposing forces at work. One is whenever we see global reflation, you tend to see downward pressure on the dollar. At the same time, we expect US interest rates to gradually rise ahead of those of other developed countries. With this rise in real interest rates and the differences between the US and other parts of the world, you are under upward pressure. All of this balances each other out and so we expect the dollar to be pegged to a range.

What do you think of india Historically, we have seen that whenever there is a major crisis in the US followed by an expansionary policy by the Fed, the emerging markets also see a ripple effect.
If you look at it from an investor’s perspective, they are currently very skeptical about emerging markets. The biggest factor holding back their interest in emerging markets is the challenges related to Covid pressure and rising cases in countries like India and Brazil. The emerging countries have finally started to take up vaccinations. They would also make a meaningful contribution to global growth. We have the same view of India. We already have the support of external demand. There has been some improvement in capital spending. In emerging markets, including India, you should see a broader recovery starting in the first quarter of next year.

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