Goodbye lowflation. Hello reflation.
Having begun the year warning a battle against excessively sluggish inflation would be the dominant economic theme for financial markets in 2015, Morgan Stanley economists led by Elga Bartsch now scent victory for central banks.
“The stage is set for global reflation,” said Bartsch and colleagues in a report to clients on Monday. “Inflation is about to or is already reflating in a large portion of the global economy.”
With 70 percent of the world economy now suffering from lowflation or a sustained period of weak price pressures, the Morgan Stanley economists forecast the average for such economies will rebound to 1 percent by the end of this year and 1.9 percent in 2016 from 0.4 percent today.
That will ease the strain for central banks with Bartsch predicting only those of Japan, the U.K., China and South Korea will be undershooting their inflation targets by a wide margin by the end of next year. That compares with 15 economies today including the U.S. and euro area.
As for the whole world, inflation will bottom at around 2.9 percent in the current quarter before accelerating to 3.4 percent next year, led by a jump in rich nations to 1.7 percent from 0.3 percent.
Such gains may still be enough to surprise financial markets with Morgan Stanley saying they are currently pricing in a weaker profile for prices. The good news is although there still may be the odd market scare as with 2013’s taper tantrum, the bank’s strategists still say stocks can benefit in the new environment with banks among those most likely to profit.
That’s because central banks won’t be hitting the brakes given inflation and economic growth will still be more modest than normal for an upswing.
The European Central Bank and Bank of Japan will keep buying assets, while Morgan Stanley questions the conventional wisdom of markets by saying the Federal Reserve will wait until December to raise its benchmark rather than acting in September. Emerging markets led by China and India are also in an easing mode.
“The expansionary policy stance reflects modest growth prospects, limited inflation pressures, and a highly levered and hence more interest rate sensitive economy,” Morgan Stanley said.
That outlook meshes with that of Credit Suisse Group AG, whose strategists last week estimated the balance sheets of major central banks will grow another 14 percent this year as they try to avoid a “false dawn” by tightening policy prematurely.
The limited risk of overheating inflation also leaves Morgan Stanley reiterating the six-year-old worldwide economic expansion could extend as long as 2020, which would make it the longest since World War II.
Investors should expect higher long-term bond yields and favor stocks of banking and industrial companies, Morgan Stanley’s strategists said in a separate report.