Emerging markets offer growth amid global slowdown, says Morgan Stanley

Amid what Morgan Stanley expects to be a disappointing level of global growth over the coming 12 months, emerging markets should not only provide growth but also accelerate into 2017.

Presenting the bank’s 'summer outlook' reports, the bank's macro team expect growth overall to slow, especially in the US, but said growth in emerging markets would accelerate, going against global consensus.

Morgan Stanley expects developed markets to lose further momentum to just 1.2% next year, whereas emerging markets are seen picking up from 4% this year to 4.7% in 2017.

Speaking at the launch event in London on Monday, chief cross-asset strategist Andrew Sheets said: “We think global growth really disappoints over the next 12 months, particularly in developed markets, particularly in the US where we see US growth at only 1.5% in 2017 versus the consensus around 2.3%... US growth might actually be decelerating somewhat going into third quarter, whereas the market is more optimistic.

“Another interesting part of this outlook that is somewhat different from those we have had over the last several years is we have developed market growth below consensus and decelerating, but emerging market growth at consensus and accelerating."

Sheets said weakness in developed market growth would lead to changes in monetary policy. He said the bank does not expect a US rate hike until 2017, which would allow emerging market central banks to cut policy rates significantly in countries such as Brazil.

He said Morgan Stanley was relatively cautious on growth, “but given our expectation that growth disappoints, given our expectation that that the Fed will now be on hold longer than we expect and given the fact that a lot of asset classes have run-up really well to date we think that that this is an environment that favours quality.”

Despite low growth rate for the US, the bank maintains that the US is still its top equity market as it is the only market which beats consensus earnings in 2016 and American companies “are of significant higher quality”.

Sheets added: “We have no objection to the idea that expanding fiscal policy would be a very helpful thing both for growth and for market pricing but I think we are more sceptical that it can actually get off the ground in the meaningful way in key markets.”

Hikes on the horizon in Europe and Japan

Morgan Stanley said Japan would like to weaken its currency but it would not be successful in doing so given limited policy options and the fact that the yen, given all its recent strength, is still one of the cheaper currencies in the G10, so it is harder to weaken.

Chief European economist Elga Bartsch said her team, which had very aggressively cut its euro area forecasts by four points over two years and by about two percentage points for the UK, do not expect a material pickup of growth in Japan, even though forecast for the country have been raised. "So, on the whole, a pretty bare outlook for developed markets on the back of the measly growth.”

The bank expects inflation pressure to remain subdued and core inflation to remain below central bank targets which would allowing central banks to pursue an easier policy than Morgan Stanley had previously envisaged, given that it no longer expects the US federal reserve bank to raise rates this year or next.

It expects the European Central Bank to cut interest rates by 10 basis points in September and for it to extend the quantitative easing programme by further six months. It also expects the Bank of England to act in August and anticipates coordinated policy action in Japan.

“So central banks keep pushing the envelope but they’re probably reaching their limit of what they can do, and also there is a debate around the effectiveness of these measures because many of the easing measures do have negative side effects of the financial system undermining the effectiveness of the stimulus hence .... the focus is moving to fiscal policy in particular for the moment in Japan and to some extent here in the UK”, Bartsch said.

“I would say that we should bear in mind that both of those countries initially planned to embark on some serious austerity and so some of the announcements that you see on the new measures you need take into account that they first and foremost are taking austerity off the table and are now pushing some mild fiscal expansion.”

European political fragmentation

Morgan Stanley, which sees 40% probability of a global recession, predicted euro area GDP will grow by 1% and the UK 0.5% in 2017. In the euro area growth will still stay relatively close to the long term potential growth rate, which the European Commission estimates at 1.1%.

Bartsch warned about political risks in Europe to follow Brexit such as the Italian referendum on the constitution and elections in the Netherlands, France and Germany next year. She also said any other exit from the EU was unlikely.

“So what we seem to observe that the political discontent is spreading from the periphery to the core countries and as here in the UK, it seems to be very much centred around immigration.... a lot to do with rising inequality and limited opportunities especially in education. But the political fragmentation that we are clearly observing, we think, would make it more difficult to push through economic reforms but also to negotiate new trade arrangements with the UK but also with the US and Canada.”