Morgan Stanley says the Federal Reserve is still likely to keep policy steady this year — but it has identified two economic developments that could force the Fed’s hand and push rates higher.
In its base case, Morgan Stanley expects no rate moves in 2026. Still, the bank warns that a persistently strong labor market or stubborn inflation could compel policymakers to tighten again. Specifically, Morgan Stanley flags two triggers: unemployment falling below 4% as a signal of continued labor-market strength, and core inflation staying above the Fed’s target, which would leave officials little choice but to remove monetary accommodation.
Recent data have kept those risks top of mind. The U.S. Personal Consumption Expenditures (PCE) price index accelerated to 4.1% — its highest reading since 2023 — underscoring upside inflation risk. At the same time, oil prices have eased after the U.S.-Iran peace agreement, a development that could damp energy-driven inflation and lend support to the view that rates can remain on hold.
Not everyone is as dovish as Morgan Stanley. In June, BNP Paribas reversed an earlier forecast that rates would stay steady and now expects the Fed to roll back the three rate cuts it predicted for 2025, projecting three consecutive hikes beginning with the December FOMC meeting. BNP Paribas said stronger inflation alongside resilient employment could force the Fed to withdraw some monetary stimulus, especially if unemployment drifts toward about 4% by year-end.
Citadel Securities has taken an even more aggressive stance. In a client note, the firm warned the Fed could start hiking as early as September 2026 if inflation broadens beyond energy-related drivers. Citadel points to accommodative financial conditions, supply-chain frictions, persistent labor-market strength, and surging AI investment as sources of sustained price pressure. The firm estimates AI-related capex could hit roughly $750 billion in 2026 and about $1.25 trillion in 2027, and it lays out a path of rate hikes in September and December 2026 followed by another in March 2027.
Fed officials themselves have not ruled out further tightening. Minneapolis Fed President Neel Kashkari told Bloomberg he’s among those who see a hike this year, citing signs of persistent inflation beyond supply shocks. After the June FOMC meeting, nine of 18 Fed officials projected at least one rate increase this year, with six forecasting multiple hikes.
Markets are pricing in meaningful chances of tighter policy. Prediction market Polymarket assigns a 53% probability of a rate increase this year, while CME FedWatch shows traders pricing possible hikes at the September, October and December meetings; the September meeting currently carries about a 46.8% chance of a hike.
Bottom line: Morgan Stanley still calls for stability, but a sub-4% jobless rate or sticky inflation could change the Fed’s trajectory — a scenario increasingly reflected in some banks’ forecasts, Fed officials’ comments, and market pricing.
Read more AI-generated news on: undefined/news
