NextFin News - Morgan Stanley has upended the consensus on U.S. monetary policy, warning that the Federal Reserve’s path toward lower interest rates is increasingly "skewed towards later and more cuts." In a research note that challenges the prevailing market narrative of a steady, front-loaded easing cycle, the bank’s analysts argue that a resilient but cooling labor market will force the Fed to delay its initial moves, only to be followed by a more aggressive series of reductions once the economic gravity of high rates finally takes hold.
The shift in tone comes as U.S. President Trump’s administration continues to exert pressure on the central bank for liquidity injections, even as the Fed grapples with a "higher-for-longer" reality that has proven stickier than many anticipated. Morgan Stanley now expects the Fed to deliver two 25-basis-point cuts in the latter half of 2025, followed by a rapid-fire sequence of four additional cuts in 2026. This trajectory would bring the terminal target range to 2.75%–3.0%, a level significantly lower than current market pricing suggests for the long-term "neutral" rate.
The logic behind this "later but deeper" thesis rests on the Fed’s historical tendency to wait for definitive proof of economic pain before acting. According to Morgan Stanley, the July employment report and subsequent labor data have heightened the Federal Open Market Committee’s (FOMC) concerns about weak labor demand. However, the bank notes that the Fed is unlikely to pivot to a jumbo 50-basis-point move unless the data shows outright job losses—a threshold the U.S. economy has not yet crossed despite the restrictive policy environment.
This delay creates a pressure cooker effect. By holding rates at restrictive levels for longer, the Fed risks over-tightening, which Morgan Stanley believes will necessitate a more forceful response in 2026 to prevent a hard landing. While Citigroup has also adjusted its forecast to include three cuts in 2026, Morgan Stanley’s call for four moves represents one of the most dovish outlooks on Wall Street for the mid-term. The divergence between these major institutions highlights the uncertainty surrounding the "Trump trade" and its impact on inflation expectations versus growth reality.
For investors, the implications are stark. A delayed start to the easing cycle means that the "pain trade" in fixed income could persist through the summer, while the promise of more aggressive cuts in 2026 provides a potential tailwind for equities and growth-sensitive assets further down the line. Michael Wilson, Morgan Stanley’s chief equity strategist, has suggested that the Fed’s slow start could actually support a new bull market in 2026 as the central bank plays catch-up with a weakening economy.
The political dimension cannot be ignored. With U.S. President Trump expected to name a successor to Jerome Powell as the Fed Chair’s term nears its end, the central bank’s independence and its reaction function are under intense scrutiny. Wall Street is betting that a new leadership, combined with mounting evidence of labor market fatigue, will eventually break the Fed’s inertia. The risk, as Morgan Stanley points out, is that by the time the Fed is ready to move in earnest, the economic momentum may have already shifted too far toward the downside.
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