Morgan Stanley boldly predicts: the Fed's interest rate cut may exceed market expectations.

Sina Finance
11 hours ago
Sina Finance Official Account
Source: Market News

Source: Jinshi Data

Wall Street giants predict that the Fed's rate cut may be larger than the market currently expects. This is the view of Morgan Stanley's interest rate strategy team after their economists updated the forecast scenarios from now until the end of next year.

Their baseline forecast is that the Fed will cut interest rates by 25 basis points at this month's meeting and will make similar cuts at every other meeting until December 2026. However, after assessing other possibilities for the U.S. economy, Morgan Stanley believes that the balance point of its various probabilities is even more "dovish."

The general interpretation of Fed Chairman Powell's speech in August at the Jackson Hole meeting is that the Fed will adopt a more accommodative stance in the future, focusing more on the weakness of labor market data rather than stubborn inflation data.

A team of economists at Morgan Stanley, led by Matthew Hornbach, evaluated three alternative scenarios that could lead to different paths for the federal funds target rate and concluded that the weighted average rate path is even lower than their current estimates.

This Wall Street giant believes that the federal funds rate may decline faster than expected in 2025 and 2026, possibly even as low as 2.25%, but the endpoint during this period may be slightly higher, around 2.75%.

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Target federal funds rate upper bound and Morgan Stanley U.S. economic forecast

This additional downward pressure has strengthened Morgan Stanley's confidence that the yield curve will steepen (i.e., long-term interest rates will rise faster than short-term rates). This has prompted them to recommend going long on US 5-year Treasuries, US long-term bonds, as well as engaging in steepening trades (i.e., traders establishing long positions at the short end of the curve while taking short positions on longer duration instruments), and going long on January 2026 Federal Funds futures.

The report titled "New Scenarios Make Us More Bullish on U.S. Treasuries," released last Friday, examined three alternative scenarios:

(1) Demand upward driven by fiscal stimulus (broader government spending and stimulus measures) and "animal spirits" (Morgan Stanley believes there is a 10% possibility of this).

(2) The Fed has a higher tolerance for inflation and the upward demand brought by "animal spirits" (Morgan Stanley also believes there is a 10% likelihood of this).

(3) A mild recession characterized by trade shocks and sudden economic disruptions (Morgan Stanley believes there is a 30% chance of this).

However, Morgan Stanley's report emphasizes that due to recession risks or the Fed taking a less aggressive stance on inflation, traders may assign a higher probability to a more "dovish" outcome. In this context, Morgan Stanley believes that the market pricing for the federal funds rate may be 100 basis points lower than the currently assumed final rate of 3.25%.