U.S. markets and the Federal Reserve have been grappling with high inflation this year, but could changes in global supply chains help make this problem easier?
-----Transcript-----
Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues bringing you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Tuesday, May 10th, at 9 a.m. in New York.
Inflation is perhaps the key to understanding the markets these days. Elevated inflation is what's driving the Fed to raise interest rates at the fastest pace in a generation. And at the risk of oversimplifying, when interest rates are higher, that means it costs more to get money. And when money is no longer cheap, anything that costs money is harder to buy and therefore might have to fall in value to find a buyer. This is the dynamic the Fed believes will eventually dampen price increases throughout the economy, and it's the dynamic that's likely contributed to stock market prices already declining.
But what if inflation were to start easing without the Fed raising rates? Could the Fed slow its rate hikes and, consequently, help stop the current stock market sell off? It's an intriguing possibility and investors who want to understand if such an outcome is likely need to carefully watch global supply chains. And to be clear, when we're talking about the supply chain, we're talking about whether companies can produce and deliver sufficient goods in a timely manner to meet demand. When they cannot, as became the case during the pandemic when consumers stopped going out and started buying more things than normal for their homes, prices rise as choke points emerge in key markets where demand outstrips supply. By that logic, if goods producers are able to ramp up production or if consumers shift back to normal, balancing consumption of goods and services, inflation would ease, putting less pressure on the Fed to raise rates.
So what's the state of global supply chains now? Are there any signs of supply chain easing that may make the Fed's job and investors near-term market experience easier? To answer this question my colleague, Asia and Emerging Market Equity Strategist Daniel Blake, formed a team to create a supply chain choke point tracker. What can we learn from this? In short, the picture is mixed. There's several factors that could lengthen global supply chain stress. COVID spread in China, for example, has led to lockdowns affecting about 26% of GDP, hampering their production of goods. And Russia's invasion of Ukraine, and resulting sanctions response by the U.S. and Europe, has crimped the global supply of oil, natural gas and key agricultural goods. But there's some good news too. Many companies are reporting initial investment and progress towards diversifying and, in some cases, reshoring supply chains, which over time should reduce choke points.
Still, the challenging news for markets is that a mixed supply chain picture means that monetary policymakers are unlikely to see supply chain easing as a reliable outcome, at least in the near term. Unfortunately, that likely means we'll continue to see risk markets struggle with how to price in a Fed that stays on track to fight inflation through higher interest rates.
Thanks for listening. If you're interested in learning more about the supply chain, check out the newest season of Morgan Stanley's podcast, Now, What's Next? If you enjoyed this show, please share Thoughts on the Market with a friend or colleague, or leave us a review on Apple Podcasts. It helps more people find the show.