Markets were closed today as S&P futures dipped slightly and the dollar rallied. With little else to do, Wall Street banks published a number of notes predicting the year ahead.
Morgan Stanley’s global economic briefing revealed a bullish tilt despite the bank being home to one of the market’s biggest (and most accurate) bears, Mike Wilson, who expects another down year for the S&P.
“Our baseline view for the US is that we skirt a recession and have a soft-ish landing. We see the Fed ending rate hikes soon because there is clear evidence that inflation has peaked and is declining, and we expect data to show a material slowing in the real economy,” read Morgan Stanley’s note, released this morning.
“From there, in line with Fed communication, we expect the Fed to keep a restrictive monetary policy while the economy runs well below potential this year and next, with cuts coming only after inflation falls substantially and looks to be on a clear path to target.”
The bank’s analysts then asked:
“But because we see elevated recession risk, some downward skew to the expected path of the funds rate makes sense. But what would it take for us to be wrong in the other direction?”
The note went on to mention stubbornly high shelter inflation (housing, rents) last month, which refuses to come down and accounted for 40% of the December CPI print.
In order for Morgan Stanley’s base case (soft landing) to come true, the bank says it needs the following to happen:
“We are relying on the fact that spot rents have stopped rising to bring that inflation down in the second half of the year, while other services inflation is not cooling much at all. It is easy to imagine our base case being realized through the end of Q1 with the Fed pausing its hiking cycle, only to find that at midyear, the disinflationary trend grinds to a halt. And if at that point, we get a couple of months of upside surprise to nonfarm payrolls like we have the past two months, the Fed could signal a re-initiation of rate hikes.”
Morgan Stanley’s opinion reflects that of every other Wall Street bank. If inflation goes lower, the Fed will cut rates. Bulls will then get the soft landing they’re hoping for, pushing stocks higher.
Anything else could result in additional rate increases, which would be a worst-case scenario for stocks.
But Morgan Stanley, much like the rest of Wall Street, refuses to acknowledge the paper tiger that US labor has become. We’ve covered this repeatedly, but the last year’s worth of jobs data does not indicate labor strength. It does, however, suggest that millions of Americans have been forced to hold multiple jobs to cope with rising inflation. These payrolls get lumped in with each monthly jobs report, which has led to several impressive “beats” in 2022.
The jobs aren’t desirable, though; in many cases, workers are trading nice full-time gigs for part-time work outside their preferred field. That kind of thing doesn’t typically happen in an economy set for a soft landing.
We’ll get a clearer picture of what the future will look like after the current earnings season comes to a close. However, based on what the big banks had to say on Friday, a recession is surely on its way, and the landing will be anything but soft.
That leaves investors in a tricky position following last week’s nice market gain. FOMO (fear of missing out) could pilot stocks even higher, but will the gains last? Probably not. Especially if other corporations chime in and issue equally bearish forward guidance in the coming days.