Introduction#
The recent conflict involving Iran has led to fluctuations in oil prices, which are now affecting expectations for U.S. monetary policy. Morgan Stanley suggests that the likelihood of the Federal Reserve (Fed) delaying interest rate cuts, or making deeper cuts, has increased.
Asymmetric Monetary Policy Outcomes#
Michael Gapen, Morgan Stanley’s chief U.S. economist, notes that the outcomes of monetary policy are not evenly distributed. He believes the Fed is more inclined to postpone rate cuts or implement larger cuts later on, rather than completely halting its easing strategy.
Rate Cut Expectations#
Currently, Morgan Stanley anticipates two rate cuts in 2026, projected for June and September. This prediction is based on the assumption that the Fed will overlook inflation pressures caused by rising oil prices and proceed with earlier-than-expected cuts. However, the firm identifies two significant risks that could alter this outlook.
Key Risks to Consider#
The first risk involves rising inflation and low unemployment, which may compel the Fed to delay cuts. With inflation currently at 3.0%, increasing oil prices could push it even higher, leading to potential delays in cuts until September and December, or even later.
The second, more critical risk is that if the Fed waits too long to act, the economic conditions could worsen. Morgan Stanley warns that prolonged high oil prices, combined with increased uncertainty, could negatively impact demand more than anticipated. In this scenario, the Fed might need to implement three rate cuts, lowering the terminal rate to between 2.75% and 3.0%.
Conclusion#
For now, Morgan Stanley maintains its baseline view but acknowledges the clear risks that the Fed may cut rates later than expected or reduce them more significantly than previously thought.