NextFin News - Morgan Stanley has abandoned its expectation for a mid-year interest rate cut, pushing its forecast for the first Federal Reserve easing to September as sticky inflation and the fiscal crosscurrents of the Trump administration’s trade policies reshape the economic landscape. The shift, detailed in a research note released Thursday, marks a significant capitulation by one of the last major Wall Street holdouts that had clung to the hope of a June pivot. The bank now anticipates only two 25-basis-point reductions in 2026, a sharp contrast to the more aggressive easing cycle many investors had priced in at the start of the year.
The catalyst for this recalibration is a stubborn Consumer Price Index (CPI) that has refused to glide toward the Fed’s 2% target. February data showed inflation holding steady at 2.4%, while core prices—excluding volatile food and energy—remained even higher at 2.5%. For U.S. President Trump, the narrative of "taming inflation" has met the reality of a supply chain still digesting the "America First" tariff regime. While the White House has touted price stability, the Federal Reserve’s own surveys suggest that nearly half of small businesses are still passing on tariff-related costs to consumers, creating a floor under service-sector inflation that Jerome Powell and his colleagues cannot ignore.
Morgan Stanley’s revised outlook reflects a growing consensus that the "last mile" of the inflation fight is proving to be a marathon. The bank’s economists, led by Ellen Zentner, noted that while the labor market shows signs of cooling, the inflationary impulse from trade policy and geopolitical tensions in the Middle East has offset the benefits of high borrowing costs. By moving the goalposts to September, Morgan Stanley is signaling that the Fed requires not just a few months of "good" data, but a sustained trend that proves the tariff-induced price spikes of 2025 were indeed a one-time event rather than a structural shift in the inflation regime.
The implications for the broader market are stark. A "higher-for-longer" reality into the autumn of 2026 puts renewed pressure on corporate margins and the housing market, which had begun to bake in a summer reprieve. For the Trump administration, a delayed rate cut creates a political headache; the President has frequently criticized high interest rates as a drag on the growth he promised to unleash. However, the Fed remains caught in a vice: cutting too early risks reigniting inflation just as the Supreme Court’s recent rulings on tariff constitutionality add a new layer of uncertainty to the fiscal outlook.
Looking at the terminal rate, Morgan Stanley still expects the Fed to eventually reach a range of 2.75% to 3.0% by the end of 2027, but the path there is now significantly steeper. The bank projects quarterly cuts will follow the September move, assuming the economy avoids a hard landing. Yet, the margin for error is thinning. With energy costs soaring due to regional instability and small businesses struggling to absorb costs, the Fed’s "data-dependent" mantra has effectively become a waiting game for a cooling that has yet to fully materialize in the official tallies.
Explore more exclusive insights at nextfin.ai.
