Morgan Stanley lays out why it thinks inflation is cooling — which should ease investors' fear of an extreme 1970s-style shock

Morgan Stanley said that investors have been worried about "stagflation" for months but that inflation is set to moderate giving markets a reason to focus elsewhere.

In a recent interview, Andrew Sheets, the Wall Street bank's chief cross- asset strategist, said that 2022, has given investors a lot to think about.

One of the many developments this year stands out. It's inflation and the impact that high inflation has had on central bank policy.

The impact of sanctions on Russia over its war on Ukraine has led to a surge in inflation in the US and other countries.

Disruptions to the supply of oil and agricultural products have caused the price of fuels and food to go up.

Monetary tightening has been used by the Federal Reserve to tame inflation. The company has begun a series of interest rate hikes.

After rocketing higher over the first five months of the year, Morgan Stanley's economists expect U.S. inflation to moderate.

According to Sheets, that should give investors more confidence about the economic outlook in the long term, as well as reduce their worries about the effects of high inflation and low economic growth on the economy.

While the US economy could avoid a recession, a period of deflation is inevitable according to economists.

The easing of supply-chain disruptions and the way inflation is measured are some of the factors that the investment bank takes into account. Today's rate is higher than it was a year ago when the world was in a Pandemic.

The peak rate of change is one of the things that is happening. When the U.S. vaccine rate was still low, prices were being compared to May of 2021.

When there was more economic activity, headline inflation will fall because it will be compared with rates when it was higher.

Some of the worst supply-chain disruptions are starting to improve.

There are fewer ships in the United States. The price of freight is going down. Retailers are reporting a lot of inventory.

Prices should fall because of the shortages. Market-based estimates of future inflation have been dropping in the US and Europe.

There are some important implications if this trend holds.

He said that inflation that is high but falling is less frightening to the market than inflation that is high but rising. The market's fear of a 1970s-style scenario should be reduced by this.

He argued that investors' expectations for central bank interest rate hikes don't need to go up much more. Fixed-income products like mortgages and municipal bonds should benefit from that stability.

As inflation fears diminish, markets are likely to focus more on economic growth, and Morgan Stanley sees a sharp slowdown ahead.

While short term bounces are possible, we would like to see more conservative estimates for earnings before assuming that the market's challenges are truly behind it.