Morgan Stanley forecasts that the Federal Reserve will implement more modest interest rate cuts in the upcoming year, while also postponing additional reductions due to ongoing inflationary pressures.
The investment bank now predicts that the Fed will forego a previously expected 25 basis point cut in January 2025 to only opt for rate reductions of 0.25 percentage points each in March and June.
The firm’s analysts highlighted a shift towards a more hawkish stance by the Fed, driven by potential changes in trade, immigration, and fiscal policies that might support a firmer inflation trajectory, leading to a more robust policy rate path.
Consequently, Morgan Stanley upgraded its forecast for the terminal rate to 2.6% from the previous 2.4%, with expectations for at least three rate cuts in 2026.
This revised outlook aligns with similar adjustments by other financial institutions, including Goldman Sachs, which also revised its rate forecasts earlier this week, citing persistent inflation and a strong labor market as influencing factors.
Market sentiment has shifted accordingly, with traders increasingly betting on the Fed maintaining its current rates in January. Data from the CME Fedwatch indicates a 91.1% probability of the central bank holding rates steady, up from a 75.4% chance the prior week.
Despite the Federal Reserve’s recent 25 basis point rate cut, the announcement was accompanied by a cautionary message from Chair Jerome Powell. He indicated a gradual approach to future cuts, influenced by stronger than expected economic growth in the latter part of 2024 and eased labor market risks.
Additionally, the incoming administration of Donald Trump is anticipated to introduce potential inflationary pressures, largely due to his commitments to expansive and protectionist policies.
