The Federal Reserve faces "no risk-free" choices as officials deliberate over the U.S. central bank’s future monetary policy decisions following an interest rate cut earlier this week, according to analysts at Morgan Stanley.
Along with helping maximize employment, the Fed is also tasked with pushing for price stability -- and the Morgan Stanley analysts led by Michael Gapen flagged that both the labor market and inflation are "moving in the wrong direction."
As a result, policymakers must try to use interest rates to strike a balance between supporting a softening jobs picture and corralling sticky inflationary pressures. In theory, cutting borrowing costs can encourage investment and hiring, albeit at the risk of driving up prices.
So far, the Fed has opted to prioritize employment, arguing that a recent tariff-driven uptick in inflation may prove to be temporary. The Fed slashed rates as expected on Wednesday, bringing down borrowing costs by a quarter point to a target range of 4% to 4.25%.
Fed Chair Jerome Powell described the reduction as a form of "risk management," signalling that weakening jobs data is playing heavily into officials’ thinking and have presented increased "downside risks to employment."
"The Fed seeks to mitigate downside risk to employment by taking its policy stance from restrictive to a more neutral setting," the Morgan Stanley analysts said, referring to a theoretical rate which neither boosts nor hinders growth.
They added that "more rate cuts are forthcoming." Crucially, the Fed’s announcement included fresh so-called "dot plot" policy projections which showed that officials are anticipating another half percentage point in rate cuts by the end of 2025.
Should these come to pass, it would leave borrowing costs at a range of 3.5% to 3.75% -- a decline from the level previously seen by the Fed when its last dot plot was released in June.
However, seven of the 19 estimates forecast fewer reductions this year, with one even calling for rates to have stayed at their prior band of 4.25% to 4.5% for the remainder of 2025. This means that debate could be fierce heading into the next Fed meetings in October and December.
Markets, for their part, are now placing a roughly 92% chance of a 25-basis point reduction in October, and about an 80% probability of a similarly-sized drawdown in December, according to CME’s FedWatch Tool.
Meanwhile, the Fed’s projections showed that most policymakers expect the economy to expand by 1.6% this year, above June’s forecast. The year-end jobless rate is seen at 4.5% and underlying inflation at 3.1%. Price gains are now not anticipated to slow to the Fed’s 2% target until 2028.
"In our baseline, prices rise and consumption slows into next year. It only reaccelerates beginning in the second quarter of 2026 after inflationary pressures begin to abate," the Morgan Stanley analysts said.
But they noted that if firms decide not to pass along much of their potential tariff-fueled input cost hikes on to customers, corporate margins may be compressed, presenting "downside risk to the labor market [...] through increased layoffs."
"Fed cuts could reduce this risk, but at the cost of higher inflation for longer, particularly if they amplify the effects of fiscal spending on demand," the analysts said, adding that policymakers are now stuck "between a rock and a hard place."
Source :
https://www.investing.com/news/economy-news/fed-rate-policy-is-stuck-between-a-rock-and-a-hard-place-morgan-stanley-says-4246514
