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Supply chain pressures ‘probably have peaked’ as the Fed looks to tighten, economist says

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Morgan Stanley Chief Global Economist Seth Carpenter joins Yahoo Finance Live to discuss easing supply chain pressures, Fed policy, and the economic outlook.

Video transcript

JULIE HYMAN: As we look at this backdrop in terms of what we're seeing in the markets, of course what's informing a lot of this trade has to do with what's going on in the economy and the outlook for interest rates. To talk more about all of that, I want to bring in Seth Carpenter. He's chief global economist at Morgan Stanley.

Seth, it's great to see you. You know, we have been talking a lot about this economic backdrop. And your latest note talked a lot about global trade and the supply chain. Our focus has been so much on the Fed side of the equation and what they're doing to combat inflation. Talk to us about that supply chain backdrop and what effect that that is going to have on global inflation, say, in the first six months of the year.

SETH CARPENTER: Thanks, Julie. Yeah, absolutely. I feel like last year, go back three to six months, the entire macro conversation was on global supply chains and its role in inflation. And then we get into this year, and the entire macro conversation is on central banks fighting that inflation. And I think it's important to keep track of the supply chain version of things. So we put out a piece that replicated an index on global supply chain pressures.

And one takeaway if you look at all the different series across the world that inform you on supply chains is, we've probably peaked. Things are probably starting to get incrementally better. Still, in level terms, in a really bad situation, but starting to get a little bit better. And if that's right, then what we should see is some of those big price rises, including some that we saw yesterday on the CPI, starting to come down, especially for those core consumer goods.

Services not as much a global supply chain issue, but those core consumer goods prices that skyrocketed last year, we think we're going to start to see some real easing of the pressure there, first in terms of lower increases and then maybe, as we get through the first quarter into the second quarter, some outright falls in those price levels.

JULIE HYMAN: Well, that's fascinating, Seth, because we were talking with our Fed reporter earlier in the show, and I'll pose to you the same question I posed to him, which is, if we're going to see an alleviation on those supply chain issues and on that lever on inflation, at the same time that we're likely to see the Fed not just winding down its asset purchase program, but also raising rates, then what is the sort of-- do we have sort of an exaggerated effect, if you will, on inflation?

SETH CARPENTER: So lots of things coming together all at the same time. Not only is the Fed winding down its asset purchases, I think the minutes from the December meeting also told us they're going to get ready to shrink their balance sheet on an outright basis at some point this year. So we'll have end of QE, start of rate increases, and a running down of their balance sheet, all of those things tightening.

So how do those come together? I think the answer is, it's going to be hard for Chairman Powell and his colleagues. They're going to start raising rates. The markets have priced in rate hikes as soon as this March meeting. And then they're going to start running down their balance sheet sometime fairly soon after that. I think what's going to happen then is the Fed's going to be monitoring the inflation data as those data come in and asking themselves how big is this overshoot, how persistent is the overshoot. Is it coming down as much as we thought, less than we thought.

And the answer to that question, how is inflation behaving, is going to inform how many times they end up raising rates over the course of this year, and more importantly, how many times they continue raising rates into next year. They have said they want to raise rates at least three times this year. They've also said they want to run down their balance sheet.

To get to four rates this year or more would probably require inflation meeting their expectations, or at least, the balance sheet runoff not doing very much. To get to three and four hikes next year the way some people in markets are calling for really would take that inflation to be much more persistent than we think is going to happen. So we think they're going to have fewer hikes by the time we get into next year than I think the market is pricing in.

BRIAN SOZZI: Yeah, that's where I want to pick up, Seth. A lot of folks in the market looking for seven rate hikes between now and the end of next year. Let's say we get five rate hikes. In that backdrop, how fast is the US economy growing?

SETH CARPENTER: Yeah, so we're pretty optimistic. If we get five rate hikes, it probably starts to crimp growth a little bit in the second half of this year and the end of this year and a bit into next year. But something with a three to four handle is possible for next year. This year, we're feeling pretty optimistic. We've got still some catch-up to go from the consumer. If you look at consumer spending relative to income, there's still a little bit of catch-up to go for this year. And that's going to be a tailwind.

And then when you think about inventories, we've had a depletion of inventory. So even though we think supply chains are starting to ease, some of that continued flow is going to go into rebuilding inventories. Accounting for what's imported versus domestically demanded, Ellen Zentner and team here at Morgan Stanley have estimated that that could be as much as 80 basis points of growth on GDP this year for that inventory rebuild.

So this year, we're still pretty optimistic, I'd say a quarter percentage point or more above consensus. Next year is going to be a little bit of an open question, depending on how the markets absorb the running off of the balance sheet, but still think next year could be a two to three handle, so pretty optimistic for this year and next.

JULIE HYMAN: You know, Seth, I also wanted to ask you about the global picture because, you know, we are usually very focused here on the United States and what the Fed is doing. But I think it also bears watching, obviously, what the ECB is doing, not to mention what's happening in China in terms of economic growth there, because they-- in part, because they have been much more stringent with the Omicron variant. So, you know, we don't talk about synchronized global growth anymore, but I wonder how you are thinking about the global picture in 2022 and going into 2023.

SETH CARPENTER: Absolutely. Let's go to China that you alluded to. And I agree, this is one area where I think the synchrony is breaking down more than would be historically. So China slowed down a lot last year. There were regulatory shifts where they were trying to control some of the real estate sector. They were trying to put in place controls for pollution. They were trying to put in place controls to do this pivot they're doing to have what they call a shared growth, shared prosperity, so reduced income inequality.

And then there were the different waves of COVID. Where are we now? I think the signals that we're getting out of Beijing reasonably clearly is that they're going to lean in with policy to make sure the economy does not slow too much. Robin Chang is Morgan Stanley's China economist. He's just been fantastic with this call. We're looking for 5% to 5 and 1/2% growth for 2022 out of China. That's a bit above-- you know, about a half a percentage point above consensus.

And the reason we're there is we think Beijing is really paying attention to this. They're really trying to balance those risks. They know that an aggressive COVID approach can limit, in a localized way, growth. So they don't want too much slowing. And they're going to be willing to ease policy to get growth back to where they want it to be. So we're actually reasonably-- well, I should say cautiously optimistic on China. But it does, in that sense, break down some of the global synchrony in terms of growth.

JULIE HYMAN: Yeah, very interesting picture. Seth, it is always great to catch up with you. Don't be a stranger. Seth Carpenter, chief global economist at Morgan Stanley, thanks so much.

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