Thoughts on the Market

Central banks are turning more hawkish as inflation risks increase. Our Global Chief Economist and Head of Macro Research Seth Carpenter explains what that means for the Fed, ECB and Bank of Japan.
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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. Today, I’m going to talk about all the movement we’ve seen in central banks and how it’s changing our forecasts.
It’s Tuesday, September 22, at 10 a.m. in New York.
Over the past two weeks, our economists here at Morgan Stanley have revised their outlooks for the Fed, the ECB, and the Bank of Japan to include more rate hikes.
Each economy faces different challenges, but all three central banks have arrived at roughly the same conclusion: growth has remained remarkably resilient despite all of the shocks hitting the global economy. And renewed energy-price pressures have increased the risk that inflation proves more persistent than they had previously expected.
The clearest example—and our biggest revision here—is the Fed.
Now for much of this year, we had actually thought the Fed might avoid hiking interest rates altogether. But in addition to this increase that we just saw at the September FOMC meeting, we now expect two additional rate hikes—in December and in March that will bring the terminal rate up to 4.25 to 4.5 percent.
While Chair Warsh has highlighted the inflationary implications of higher energy and commodity prices, for me, the more important signal was the assessment that policy is not sufficiently restrictive.
So in our view, the Fed appears to be reassessing not just the inflation outlook, but the amount of restraint that is required to bring inflation sustainably back to target.
But even with all of that said, we’re still looking at this shift as more of a recalibration of policy for the Fed rather than a fundamental shift in policy. And so the market may have—just may have—overestimated how much hiking is left.
But the shift does have clear and important market implications.
Our rate strategists expect investors to pull forward additional tightening expectations in the near term, while increasingly questioning how long policy can remain at restrictive levels before growth starts to slow.
But more broadly, the Fed now appears a bit more sensitive to energy-driven inflation pressures, and that strengthens the case for a firmer dollar.
Over recent months, rising energy prices have supported the euro because investors have seen the ECB respond more aggressively than the Fed. That maybe former asymmetry could be changing.
Our foreign-exchange strategists therefore continue to favor dollar strength, particularly against the yen.
Now Europe does face a similar inflation challenge to the Fed, though through a different mechanism.
The renewed rise in natural-gas and other energy prices has led our economists to revise up their inflation forecast materially and, therefore, to add in another ECB rate hike in December.
But we have got to keep in mind that it is not energy prices all by themselves that have changed the outlook.
Economic activity in the euro area has also proven to be much more resilient than we had anticipated. And that reduces concerns that an additional modest tightening of policy would derail growth.
And so if you take it all together, the ECB is increasingly focused on preventing higher energy costs from feeding into broader inflationary dynamics.
Now Japan might seem different, but the underlying story is really surprisingly similar.
For decades, the BoJ’s challenge was generating inflation. But now policymakers are now increasingly concerned about the possibility that inflation will overshoot its target.
After the BoJ’s hike last week, we expect it to raise rates to 1.5 percent in December and then raise rates further, to about 1.75 percent, in March.
Like the Fed and the ECB, the BoJ faces an economy that has absorbed tighter financial conditions much better than had been expected.
And yet, unlike the Fed and the ECB, our strategists believe that markets have become too aggressive in pricing the eventual destination of rates. And that creates scope for expectations to be revised lower over time.
As a result, while Japanese rates may continue to rise gradually, our foreign-exchange strategists still expect a broader trend of yen weakness to emerge once temporary positioning effects fade.
So the common thread across all three of these central banks that I’ve discussed is that, while the energy shock has changed the inflation conversation, the resilience in growth has further changed the policy conversation.
And so for investors, next year is probably going to be characterized by higher policy rates and a stronger dollar than markets expected at the beginning of the year.
Well, thanks for listening. And If you enjoy the show, please leave us a review and share Thoughts on the Market with a friend or colleague today.

Our CIO and Chief U.S. Equity Strategist Mike Wilson discusses why quality stocks, strong earnings and price momentum support his view that the bull market remains intact.
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Welcome to Thoughts on the Market. I'm Mike Wilson, Morgan Stanley’s CIO and Chief U.S. Equity Strategist.
Today on the podcast I’ll be discussing the ongoing mid-cycle transition.
It's Monday, September 21st at 11:30 am in New York.
So, let’s get after it.
The S&P 500 is near record highs. That’s despite rising energy prices, two wars running in parallel and AI safety concerns back in the headlines. Meanwhile central banks are tightening. On paper, that's a lot of reasons to be nervous. So are investors just being complacent? I don't think so.
More than 40 percent of the Russell 3000 has fallen at least 20 percent since June, while the S&P 500’s forward price earnings multiple has fallen back to 19 times, which is almost 20 percent lower than a year ago. At the same time, median stock earnings growth is running around 15 percent, and revisions breadth is back near cycle highs. Falling valuations alongside strong earnings growth is not complacency. It is the definition of a classic mid-cycle transition.
That distinction matters because mid-cycle markets tend to frustrate almost everyone. The index can remain resilient while much of the market corrects. Earnings can stay strong while multiples fall. And leadership can change without the bull market ending.
Last week’s Fed meeting fits squarely into that framework. The 25-basis-point hike was largely priced, so the real information was Chair Warsh’s willingness to follow through on his commitment to fight inflation. Recent core inflation data were firmer than expected, but the details were not uniformly hot.
Some of the upside was concentrated in a handful of categories, shelter remained soft, and tariff pass-through appears to be fading. That gave the Fed room to act without forcing investors to assume we are heading into another 2022-style tightening campaign.
In my view, the hike can enhance credibility. If investors believe the Fed is acting early enough to contain inflation, a higher policy rate can reduce uncertainty and term premium rather than automatically driving long-term financing costs higher.
But the rate hike is not my concern. A few additional hikes over the next year are unlikely to end this bull market if earnings remain strong. The bigger unknown is how a Warsh-led Fed approaches the balance sheet, money supply, and credit growth. His philosophy has historically leaned more monetarist than prior Fed chairs. However, we still don’t know how aggressively he will apply it – or how much influence he will have over the rest of the committee. That matters because the private economy is using more capital, and an overly restrictive approach to liquidity could become more consequential than the policy rate itself.
This is one reason I continue to favor large-cap quality. High free-cash-flow yield, low accruals, and operating-efficiency factors are leading, while the high-sales-per-employee factor has been one of the strongest recent performers. That also aligns closely with our preference for AI adopters rather than the enablers.
Price momentum is not disappearing. But its composition is changing toward quality, services-oriented, asset-light, and fee-based businesses. That is exactly what should happen during a mid-cycle transition.
The near-term swing factor remains energy prices. Another meaningful rise in crude or refined products would put upward pressure on the expected policy path, long-end yields, and bond volatility in an unhealthy way. It would also arrive during a period when midterm-election seasonality often produces a 5 to 10 percent index correction.
In a worst-case near-term scenario, the S&P 500 could trade near 7100, but I would view that as a tactical correction within the bull market – not a change in our fundamental views. Either way, I remain convicted in our 8,000 year-end price target.
The bottom line is that this market is behaving exactly like a mid-cycle market should: valuations are compressing, earnings are carrying the load, and leadership is moving toward quality. The index may look calm, but plenty of concern has already been priced at the stock level.
The mistake would be confusing resiliency with complacency—and missing the rotation taking place in plain sight.
Thanks for tuning in; I hope you found it informative and useful. Let us know what you think by leaving us a review. And if you find Thoughts on the Market worthwhile, tell a friend or colleague to try it out!

As President Xi heads to Washington, trade, rare earths and AI are set to dominate the agenda. Our Head of U.S. Public Policy Research Ariana Salvatore unpacks what the meeting could mean for supply chains, tech stocks and the broader market.
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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of U.S. Public Policy Research at Morgan Stanley.
Today, I'll be talking about next week's U.S.-China summit, specifically the bilateral trade relationship, what we can expect on critical minerals and rare earths, AI dialogues, and what it all means for markets.
It's Friday, September 18th at 10am in New York.
President Xi is scheduled to visit the White House on September 24th for his second meeting with President Trump this year, and his first White House visit in roughly a decade.
The meeting follows President Trump's visit to Beijing in May, where the two sides established a framework for what they call a more constructive relationship of strategic stability. That meeting also produced new trade and investment dialogues, commitments around agricultural purchases and aircraft, and an agreement to begin a dialogue on artificial intelligence.
But next week's summit comes at an important moment because several of the temporary arrangements that helped stabilize the economic relationship are due to expire later this fall.
We think there are three areas to focus on.
The first is trade. The current U.S.-China tariff truce is scheduled to expire in November. Now, public reporting suggests that the two governments are discussing an extension alongside potential announcements on agriculture, non-tariff barriers, and a relatively narrow set of goods that could see lower tariffs.
The question for markets, therefore, is less whether next week produces a comprehensive new trade agreement and more so on whether the two sides can extend the current period of stability and prevent another significant increase in tariffs.
The second area is critical minerals. This is probably one of the clearest examples of the leverage that each side has over the other.
Washington, we think, wants more predictable Chinese exports of rare earths and other critical materials used across semiconductors, autos, aerospace, and defense. Beijing, meanwhile, has been pushing back against U.S. restrictions on Chinese companies' access to advanced technology.
Public reporting suggests that both of these issues are part of the negotiations heading into the summit, and the timing here is really important. November 10th is an upcoming cliff affecting China's rare earth restrictions and U.S. technology controls, followed later that month by another deadline covering certain minerals. So what happens next week could determine whether those restrictions remain suspended or begin to snap back.
The third area is technology, and increasingly artificial intelligence. The two leaders agreed in May to establish an AI dialogue, and President Trump has specifically said AI will be discussed next week.
Reporting also shows that shared AI risks could be one area for discussion, although the broader competitive relationship makes a comprehensive agreement difficult, we think. From a policy perspective, the most important point is that technology restrictions are moving beyond advanced chips. The debate includes cloud and compute access, model distribution, procurement, and potentially the use of certain foreign AI models themselves.
In other words, we think that while the summit could produce something like an agreement to keep talking on AI, the underlying shift matters more. AI sovereignty pushes both the U.S. and China toward more restrictions or heavier government involvement even over a longer period of time.
We expect that a middle path is the more plausible U.S. approach. So think targeted restrictions on specific Chinese developers rather than a blanket prohibition on Chinese open weight models. But even that would reinforce what we've called the two worlds thesis, increasingly distinct U.S. and Chinese tech ecosystems with separate infrastructure, supply chains, standards, and distribution channels.
There could also be a host of other issues on the agenda, specifically the U.S.-Iran conflict, which we see as a tail risk into the talks.
So what does all this mean for investors?
Even a constructive summit is unlikely to reverse the structural push toward technology and supply chain diversification. In fact, we argue that greater U.S.-China bifurcation will actually reinforce investment in parallel ecosystems, semiconductor capacity, data centers, cloud infrastructure, power, and critical mineral supply chains.
In that sense, actually less geopolitical friction next week could reduce near-term market volatility, but without necessarily changing the underlying investment cycle.
So, the key question coming out of the summit is not simply whether the relations are improving or deteriorating. It's whether the two sides can preserve enough stability to manage their competition while the longer-term process of de-risking continues underneath.
Thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today

After raising interest rates for the first time in more than three years, the Fed still doesn’t see policy as restrictive. Our Global Head of Fixed Income Research Andrew Sheets breaks down what that could mean for the monetary policy path.
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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.
Today, why the Federal Reserve may have raised interest rates and yet still thinks that monetary policy is providing support.
It's Thursday, September 17th at 2pm in London.
Yesterday, the Federal Reserve raised interest rates by a quarter of a percent. That part was widely expected. What was more notable was how Chair Warsh described it.
At the press conference following the action, he said that the Fed had removed "a dose of accommodation," and he said that both he and many of his colleagues were hard-pressed to describe broader financial conditions as restrictive.
That's an important distinction that now moves to the heart of the market debate.
If monetary policy is already restrictive, another rate hike means that the Fed is pressing harder on the proverbial brakes on the economy. But if policy is still accommodative, a hike is more like easing off the gas. It means the Fed is simply providing a little less support. And if that is how the committee sees the world, it suggests that there could be further to go.
Following yesterday's meeting, Morgan Stanley's economists now expect two additional quarter point rate hikes in December and March, taking the Fed's target rate range from 4.25 to 4.5 percent; and we then expect those rates to remain there through the rest of 2027.
Three things are driving this updated view.
First is exactly that language around accommodation. The interest rates that keep the economy in balance are always a mystery when viewed in real time. But given booming earnings growth, loan growth, and corporate activity, it's not obvious that the current level of interest rates are holding back activity for the economy as a whole. The Fed may believe that as well, making higher rates a little more palpable.
Second is inflation. Chair Warsh repeatedly emphasized that trends matter here more than individual data points, and on that basis, inflation still looks too high. Too many categories are still running above 3 percent. The Fed simply does not sound convinced that inflation is moving sustainably back towards its 2 percent target as fast as it would like.
Third is geopolitics. Chair Warsh explicitly cited geopolitical developments as one of the things that had changed since their meeting in July. He also made it clear that the Fed is watching not just high oil prices, but so-called second-round effects. And whether higher prices for fuel translate into higher prices for things that require a lot of fuel.
Airline tickets, for example, are one of the areas of the economy where prices are going up the fastest. Higher oil prices are a key reason why. And so with energy markets still severely disrupted, this remains a wild card.
There is, maybe, one other wrinkle. The committee also raised its estimate of the so-called long-run neutral interest rate – the rate that it thinks we'll ultimately end up at over the long term that will keep the economy in balance. And it raised this to about 3.25 percent.
This is an uncertain estimate, and Chair Warsh himself downplayed its importance. But directionally, a view that the interest rate that keeps things in balance is higher means that any given interest rate that we see today is less restrictive on economic growth.
It's less elevated relative to that neutral rate than we previously thought. That, too, leans towards the case for more tightening and more rate increases rather than less.
None of this is set in stone. If energy prices fall, geopolitical tensions ease, or inflation improves more quickly, the Fed could stop earlier. But for now, we think the important message from this week's meeting was not simply that the Fed raised rates.
It was that even after doing so, it still doesn't think that policy is especially tight. And if that's right, there may be still more to do.
Thank you, as always, for your time. If you find Thoughts the Market useful, let us know by leaving a review wherever you listen. And also tell a friend or colleague about us today.

Our Global Head of Macro Strategy Matthew Hornbach joins our Chief U.S. Economist Michael Gapen to discuss the Fed’s potential next moves and how energy prices are influencing market expectations.
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Matthew Hornbach: Welcome to Thoughts on the Market. I'm Matthew Hornbach, Global Head of Macro Strategy at Morgan Stanley.
Michael Gapen: And I'm Michael Gapen, Morgan Stanley's Chief U.S. Economist.
Matthew Hornbach: Today, what the Federal Reserve decided at its September meeting and what it could mean for rates through the end of the year.
It's Wednesday, September 16th at 4pm in New York.
So, Mike, the Fed raised rates by 25 basis points at this week's meeting. What stood out to you the most in the decision? And when it comes to inflation, how do you think this 25-basis point rate hike is actually going to affect the inflation outlook?
Michael Gapen: Yeah, so certainly the decision was in line with expectations. You know, obviously what we've learned in the very broad sense is that inflation isn't moving fast enough in the direction that the Fed wants. So, it's responding by tighter monetary policy. And that does set up a very interesting question which you just asked, which is: Well, is it going to work? Is this the right response to the inflation that we're seeing?
So, if you do go back and reread that Jackson Hole speech, there's not a lot in there about the drivers of inflation, what's causing higher inflation. But it's clear the only response to above target inflation from the point of view of the chair was tighter monetary policy. So, the Fed is in a bit of a pickle.
Most of us believe the majority of the inflation we're seeing is supply side driven from tariffs, from energy. At least in the past, let's call it supply chain disruptions, a de-globalization narrative. Some of it is demand side driven through AI. But I think we're all looking at that thinking modestly tighter rates isn't necessarily going to bring down that AI-related inflation.
So, we're left to conclude that the Fed's in this uncomfortable position of saying, "Well, a lot of the inflation that we're seeing is supply side driven and from the structural AI story that we're not convinced higher rates can maybe address."
So I think the answer would be, if inflation's going to come down, then higher rates will be weighing on the parts of the economy that are more interest rate sensitive and generally soft already.
Matthew Hornbach: Is this a one and done? Or do you think that when the Fed actually goes ahead and hikes rates after a long pause, they are thinking about delivering more than just one rate hike?
Michael Gapen: Yeah, I strongly believe the committee as a whole is thinking in terms of more than one move. Monetary policy doesn't, say, hyper-react. It reacts with a bit of a delay. So, to your point, they've been on hold for a while. When they think about changing policy, then they're thinking about a series of moves.
So, I think in their mind, if they're raising rates, there's a strong probability that they will do at least one more or two more. They're never going to think that a 25-basis-point move in the funds rate will fundamentally change the macro-outlook. So, I don't think they'd ever walk into this thinking one and done.
Now, it is possible we get an ex-post one and done. So, how could that come about? If it is true indeed that we're right that a lot of this inflation is supply-side driven. It is coming down. It's clear that the three- and six-month annualized rates are pointing to disinflation into year-end. We can debate whether it's fast enough or not.
But if disinflation continues to happen, then the Fed will have hiked, expect to maybe do another one. But by the time we get there, inflation has improved enough, and they end up not doing it.
So, they would sound like, "Oh, we're still ready. We still think we've got more work to do." But in the moment, the data just arrives in a way that they stay where they are. So you would look back and say it was a one and done, but I don't think they go into this thinking one rate hike is going to fundamentally change the story.
Matthew Hornbach: Now, of course, the data that we'll get between today and the December meeting will likely have an impact on their decision-making – as well as any revisions that we end up getting.
And I think one of the stories that investors have been talking about are some of the methodological changes that the Bureau of Economic Analysis is implementing into the PCE inflation data. Do you see any scope for those types of revisions to lend itself to a one and done type of a policy for this year?
Michael Gapen: It is possible. There's uncertainty about what actually those revisions are going to bring. But quality adjustments to software, for example, will over time likely bring inflation lower. Some of the revisions to the other categories. So, we do think it will on average lower year-on-year rate of inflation by about 1/10 or so, maybe a little more.
So, it could show up on the high side. And then you've got what looks to be a different path.
So yes, I think one of the reasons to maybe go slower, think about perhaps a quarterly pace of hikes, as opposed to, "Oh, we're just going to ramp up three, four meetings in a row," is to let some of this play out. See what those revisions look like.
So yes, it could contribute to a world where revisions plus softness in the incoming data mean they hike, say, in September, don't do another one after that. Or those revisions are part of the reason why they think a slower-moving cycle rather than a more aggressive one is appropriate.
Matthew Hornbach: Does the labor market play any role today in monetary policy?
Michael Gapen: I think it's certainly secondary, if not tertiary. I don't want to say that the committee as a whole sees the labor market just fine and we don't have any concerns there.
What's super helpful from the rate hike perspective is labor income, wage income out of the labor market is still decelerating and pretty modest. It doesn't suggest that the economy's overheating and the labor market is a source of upward pressure on inflation. So, I think that's beneficial in terms of thinking of the rate hike cycle.
In the other direction, I'd say we've had a number of months now of, kind of, you know, let's call it 50,000 to 70,000 jobs a month on average if you kind of smooth through some of the volatility. That's not amazing, but it's not awful either.
So Matt, I'd like to turn it back to you. This is of course the economist's perspective. When we translate this into the rates market; rates market clients may have a very different view. But I would be interested to hear your thoughts on how you think the rates market is dealing with the inflation. I don't want to say impulse, but let's call it the sticky disinflation we're getting, the sources of that inflation, and how it sees monetary policy reacting.
How is the rates market digesting all of this?
Matthew Hornbach: So, I think actually investors are reasonably nonplussed about what's happening in the underlying rate of inflation in the country. But what has inserted itself into the conversation is the price of energy and how impulsively energy prices have risen over recent months.
When we look at how market prices evolve with respect to the path for monetary policy, what we observe empirically is that if energy prices are going up in a given week or in a given month, the market reprices to a more hawkish path for Fed policy. And if energy prices come down in a given week or a given month, and we see the market pricing towards a less hawkish path for monetary policy.
So, the primary driver of how the markets are pricing the future of Fed policy is, in fact, the changes in the price of energy commodities. So, Brent crude oil, WTI crude oil, gasoline prices. And so, this is something that we just can't get away from.
There are, of course, other things that do influence the level of Treasury yields, but I would suggest that they are more secondary or tertiary themselves in terms of… Similar to the labor market. I would say they have less of an impact on the overall level of yields.
So, with a market-implied hiking cycle from the Fed at about three hikes or so from here, given that the Fed just delivered one rate hike, you know, the 10-year treasury yield is around 5 percent. It was much lower earlier this year, and we were pricing in two rate cuts at that point in time.
So, you get the sense that if the market's moving from pricing in two rate cuts to pricing in four rate hikes, and the 10-year yield goes from 4.25 percent to 5 percent, obviously there's a relationship there.
One factor that investors are certainly interested in is – how does the debt stock play a role in the level of yields? And one of the things that I've been telling people to consider is that it's not the level of the debt, the amount of debt in the economy that matters most for the level of interest rates – as odd as that may be to hear for listeners. It's how quickly that debt stock grows.
So, if the debt stock is going up at a certain pace, and that pace is within the bounds of investor expectations, then it typically doesn't have that big of an impact on the bond market. So, one of the factoids that may surprise people is: about four years ago, the news media was very interested in the fact that the amount of debt in the United States had breached $31 trillion. And, the 10-year treasury yield at that time had peaked at about 4.25 percent, somewhere around there.
Well, earlier this year, before the conflict in Iran began, the 10-year treasury yield was also around 4.25 percent. But this is four years later, and over these four years, the U.S. has added $9 trillion to the debt.
So, here again, this is a good example, I think, of this idea that you can have a dramatic expansion in the debt from [$]31 trillion to [$]40 trillion, and yet the 10-year treasury yield itself is broadly unchanged.
And so that just, I think, should tell investors that it's not the size of the debt that matters per se. Lots of other factors can influence the level of treasury yields. And how the market thinks about the Fed is certainly among the more important of those.
So, Mike, just want to say thanks again for taking the time to talk after another FOMC meeting.
Michael Gapen: Great speaking with you, Matt.
Matthew Hornbach: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen and share the podcast with a friend or colleague today.