In the first of a two-part discussion, our roundtable explores how AI investment, trade and consumer spending are sustaining global growth, and what could put that resilience at risk.
Read more insights from Morgan Stanley.
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Seth Carpenter: Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist and Head of Macro Research.
Michael Gapen: I'm Michael Gapen, Chief U.S. Economist.
Jens Eisenschmidt: I'm Jens Eisenschmidt, Chief Europe Economist.
Chetan Ahya: And I'm Chetan Ahya, Chief Asia Economist.
Seth Carpenter: And today, our fourth quarterly economic roundtable discussion is going to try to take a wide-angle view on the global economy – and it has held up despite higher interest rates, higher energy prices, geopolitical uncertainty, you name it.
It's Thursday, October 22nd at 10am in New York.
Jens Eisenschmidt: And 4pm in Frankfurt.
Chetan Ahya: And 10 pm in Hong Kong.
Seth Carpenter: All right then. Let me start with that big question Why has global growth held up better than maybe would have been expected given everything that we've seen ?
Mike, maybe I'll start from the U.S. perspective with you. What do you think has mattered most? What is driving – if I dare use an overused word – the resilience of the economy?
Michael Gapen: Most of us believe AI-related spending is interest rate insensitive and geopolitically insensitive. And certainly, I think the data has borne that out. And in the direct translation of AI hypercaler Capex spending to growth, we find that AI is accounting for 4/10 to 6/10 contribution to growth in any given quarter. You could nudge that a little higher if you think it’s creating productivity, which we do.
And that spending is underpinning asset market appreciation – or certainly has for the past several years. And that is underpinning resilient spending by upper income households.
So, I think in the U.S. the clear answer is AI-related spending, but also its linkage to asset markets and upper-income households.
Seth Carpenter: Jens, let me come to you for the European view. I mean the AI story has been a little bit different in Europe. I think consumer behavior sometimes can differ in Europe than in the United States.
What would you say is the story behind the resilience of economic growth there in Europe?
Jens Eisenschmidt: It’s similar in the sense that there is a clear element of also of AI-related external demand. That even in Europe now the phones are ringing, given that we are more typically seen as on the more higher cost end of the spectrum.
So, I think there was clearly in the second quarter data, export-led growth elements related to AI or delivery into that. There was also an element of geopolitical tensions helping some of those producers – say, chemical industry in Germany comes to mind – that would deliver products that would previously be delivered out of the Strait [of Hormuz].
So, that is another element. And then, yeah, the consumer held up better than had expected. Or that you could have expected given the rise in energy prices. So all in all, that got us a relatively solid second quarter print. And we expect this to be more or less repeated also in the third.
Seth Carpenter: Chetan, the export story is pretty important. You've been writing about a big CapEx cycle and big industrial cycle in Asia. So, when you think about the Asia story and why the economic growth held up in spite of the global shocks, how would you characterize that?
Chetan Ahya: Yeah. So, Asia is benefiting from a strong pickup in CapEx, which initially was led by the tech sector, but is now broadening out to energy, defense, and broader industrial investments. Exports are strong, and showing some signs of broadening out from tech to non-tech goods too.
This has meant that the region has faced positive terms of trade situation despite higher oil prices. Higher export prices have boosted corporate profits and in turn government tax revenues, offsetting the fiscal pressures from higher fuel subsidies.
And when you're thinking about higher interest rates that you are seeing globally and also in Asia, what is different in this cycle is that the macro stability indicators are in a good place. Current account surpluses in the region have widened quite significantly. In fact, it is $1.6 trillion or 4.2 percent of GDP.
Also what we have is the private sector balance sheets outside of China are quite healthy.
So, all in all, both higher oil prices and interest rates have not disturbed the CapEx and growth cycle in the region.
Seth Carpenter: Is there a lot of dispersion across sectors, across countries for this cycle that you’re talking about? Can you go a little deeper there?
Chetan Ahya: Yeah. So let me start first with the story on investment versus consumption So initially, the growth story in the region started with a pickup in exports and CapEx. But what we have seen is that this has now broadened out into a dynamic where we see an improvement in the labor market and therefore consumption growth.
So, we have this recovery broadening out from exports to CapEx to consumption.
And within the region, when you're thinking about different economies. Initially, we saw very strong growth in Korea and Taiwan. But now we have seen growth being strong in all parts of the region, especially in economies like India, Japan, and also some of the Southeast Asian economies like Malaysia and Singapore.
Seth Carpenter: I want to stay on this broadening theme, Michael.
Is all of the CapEx spending, all the investment spending, by business in the United States, is it just an AI story? Are we seeing any broadening of the investment story in the U.S. beyond AI? Or should we just resign ourselves that the rest of the economy is going to stagnant?
Michael Gapen: No, I do think we are seeing evidence of some broadening out. It is most clear in manufacturing.
So, I do think it points to some broadening out in the AI story beyond the narrow AI story into something that is broader that both Chetan and Jens have referenced about in a multipolar world needing to build out redundancies in supply chain.
Maybe there's some incentive to do some reshoring. So, whether it's a spillover effect from AI or a spillover effect from geopolitics writ large, I do think there's some evidence that we're seeing the broadening out.
I would just caution and say, just remember, manufacturing in the U.S. is relatively small. It's only about 10 percent of output and maybe 10 percent of employment. But nonetheless, it's there. So, it's not just an AI story. I think you can characterize it as a bit broader.
Seth Carpenter: Let me come to you, Jens, on this. We've seen an investment story play out for a while in Europe. There was a lot of discussion about defense especially in Germany –infrastructure especially in Germany.
Is that still an important part of spending in Europe, the investment side of things? And how important is investment relative to household?
Jens Eisenschmidt: Yeah. No, I mean, I think in, in terms of the shares; and GDP shares in spending, you're talking about 50 percent versus 20 percent. So, consumption is the more important one…
If you talk about relative expectations, so I think there your question really points at a key component of the forecast. If anything, you could expect maybe some more dampening from here, given that energy prices have increased further, and at some point the consumer will just capitulate. Or at least, need to show some signs of retracement. While investment has so far, in the aggregate at least, not shown any signs of a big revival.
And if anything, this is what we would expect more investment from here – be it related to, you know, a progressive AI build out.
Or be it because we anyway expect some more positive investment dynamics given where we are in the cycle and given that the ECB has decreased rates last year. And at some point, this typically shows up in investment demand.
So, long story short, the relative importance as a growth driver should increase of investments, vis-a-vis consumption. I think that is that is relatively clear. The question is just the magnitude here.
Seth Carpenter: How much do you worry then that not only is investment going to become bigger share of growth? That consumption could weaken even more because energy prices chip away at purchasing power of households? Is that a relevant factor for Europe?
Jens Eisenschmidt: I think that has to be the number one growth worry going forward So essentially, you come down in terms of wage increases from very high level that were reflective of past inflation.
So, the European wage setting process always lags inflation, and so basically today's wage agreements are reflective of yesterday's inflation.
But now we are going above 4 percent, very likely on our forecast. Not an awful lot above 4 percent, but still above.
Then it becomes a question of how long this is going to persist. If you just believe the future curves in energy markets – not long. But then if you look at more details in terms of, for instance, where diesel prices are likely heading, you can become more pessimistic, and ultimately, this is what matters for the consumer. So long story short, big risks here, of course.
Seth Carpenter: All right. So, a consumer that's not exactly pulling its weight leads me back to China. Key economy in the world, one of the biggest economies going. But when it comes to demand, aggregate demand, China has been in this deflationary cycle for a while. The household sector has been pretty soft in terms of its demand.
What are we looking at there in terms of the consumer in China, the demand side of things in China? is that likely to change anytime soon? And can the global economy look to China as a source of extra demand to keep this expansion going?
Chetan Ahya: Unfortunately, I think the short answer to your question is no. We are still very cautious on China's consumption outlook. And what we have been characterizing the China growth story as it's going through a K-shaped recovery.
On one side, you have the strength in exports and AI CapEx. And on the other hand, we have a very weak consumer.
Now, why is the consumption growth weak in China? So firstly, the property sector has still not completed the adjustment cycle.
So, from consumer standpoint, they have still a weak labor market and wage income growth. On top of that, they have seen this massive decline in asset prices. And, so they are actually, de-leveraging at a very rapid pace. The outstanding debt for consumers is contracting at the rate of 1.5 percent. 1.5 percent is not a big number, but just to see that contraction is quite surprising.
And so therefore, all in all, China's consumption growth continues to remain weak. We do think that there is a possibility that the policymakers respond to this weak growth and provide some support. But we're not expecting that support to be big fiscal expansion in a way that you get a major surprise on the consumption outlook for China.
Seth Carpenter: But as we started off saying, things are holding up, and so that fact brings up a question in my mind. Where are the risks? Where are the downside risks? And so, Mike, maybe I'll start with you.
What do you think would lead to a downturn in the U.S.? Where's the biggest vulnerability? What do we have to look out for?
Michael Gapen: Well, I think in the, the near term, I do think higher rates pose a vulnerability. So, I would say if the central bank has to shift to a much more dramatic tightening cycle and interest rates go a lot higher, that would be a near-term vulnerability. But I think if we look further out, if the resiliency of the economy is driven by the AI investment cycle, then I think a potential over-investment cycle is the greater risk.
Seth Carpenter: Alright. Jens, what about in, in Europe?
Jens Eisenschmidt: Clearly we have a discussion among European, in particular monetary policymakers, as evidenced by the latest accounts of the ECB about the degree to which long rates have increased. Maybe, too much and, you know, present a significant tightening of financial conditions.
And juggling that in a good way will certainly be a risk and reason to be cautious.
So, I would say, here the three risks. Again, consumption because of energy prices, interest rates, or a too tight monetary policy stance. And of course, the investment cycle overall.
Seth Carpenter: Chetan, you get the last word in Asia
Chetan Ahya: So, I would say, Seth, two risks. One is higher oil prices and the second one is, if you see a contraction in AI investments in the U.S. and therefore in Asia as well.
So, on oil prices, I would say a threshold of $130 to $150 of oil would be a problem for the region. It would make the governments finally do resort to higher oil prices for the consumers.
And if you get a combination of higher oil prices and lower AI investments, that would be quite a big shock to the region's growth outlook.
Seth Carpenter: Super helpful. And I think that's probably a good place for us to stop for today.
We talked about global growth. It's been holding up really well. Sources of that resilience probably differ a bit across regions, but investment is important and becoming probably more important over time. And that investment boom is spreading through trade. Domestic demand in parts for Asia. Europe has got its own story going on. And obviously, the consumer around the world matters a lot.
That current outlook though, of a reasonably strong economy with this shock from energy that's driving up inflation, means that the policy side of things, especially monetary policy, is now becoming kind of complicated.
So, what should a central bank do? When we come back tomorrow, we're going to ask questions about the Fed, the ECB, the Bank of England, the Bank of Japan. How they're thinking about what's going on, the tightening that needs to be done, whether or not this is going to be a fully synchronized hiking cycle.
And I guess most of all, what's going to tell us when the policy hiking has gone far?
Mike, Jens, Chetan, thanks so much for joining today. And to the listener, thank you for listening, and be sure to tune in tomorrow for part two of our conversation.
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