Morgan Stanley Sticks With "June Rate Cut" Forecast, Standing Alone on Wall Street in "Delaying the Rate Cut Wave"

Oil prices surge reignite inflation concerns, Wall Street’s rate cut expectations fade, but Morgan Stanley chooses to go against the flow.

On March 16, according to Bloomberg, as many institutions delay their first rate cut by the Federal Reserve to September or later, Morgan Stanley insists that the Fed will restart rate cuts in June and complete a second cut in September. This stance sharply diverges from current market pricing and peer opinions, making it a clear “minority” position on Wall Street.

Morgan Stanley Chief U.S. Economist Michael Gapen said at a roundtable on Monday, “We still maintain our forecast of rate cuts in June and September, though the risk is that the timing could be delayed.”

After the outbreak of war in Iran, oil prices soared sharply, and market concerns about a resurgence of inflation quickly heated up. Traders significantly reduced their bets on the Fed cutting rates this year. Meanwhile, last week, the Treasury market experienced a large-scale sell-off, with the two-year U.S. Treasury yield rising to nearly 3.75%, surpassing the Federal Reserve’s excess reserve rate — a rare occurrence.

The report notes that Michael Gapen also acknowledged that if the Fed chooses to wait until September or even December to initiate the first rate cut, the next rate cut window could be pushed back to 2027.

Morgan Stanley’s June rate cut forecast is supported by its core logic

The report states that Morgan Stanley’s maintenance of the June rate cut forecast is primarily based on its assessment of the nature of the oil price shock — viewing it as a controllable, phased external shock rather than a persistent pressure capable of fundamentally altering inflation trends.

Seth Carpenter, Morgan Stanley’s Global Chief Economist, pointed out that “the inflation spike driven by oil prices is likely only temporary.” He said, “If the oil shock becomes severe enough to start dragging down economic growth, over time, it will actually lower the potential inflation trend, especially core inflation.”

Regarding economic growth, Michael Gapen believes that current oil prices are still within the economy’s tolerable range.

“The economy can absorb oil prices of $90 to $100 per barrel. It would take sustained prices in the $125 to $150 range for a significant recession probability to develop.”

He also noted that the probability of a U.S. recession has increased from about 10% before the outbreak of military conflict to around 20%.

Morgan Stanley also emphasizes that if oil prices remain high at $125 to $150 per barrel for a long period, it will significantly dampen consumer spending, which would then require the Fed to step in to provide support.

It is noteworthy that the market pricing and other Wall Street institutions’ expectations have shifted markedly due to the oil price shock, leading to a significant change in the outlook for Fed rate cuts.

Futures contracts linked to the Fed’s policy rate are currently only pricing in a 25 basis point cut in December, whereas last month, the market expected at least a 50 basis point cut this year. The probability of a 25 basis point cut in September is about 60%.

The sharp volatility in the Treasury market further confirms the shift in market sentiment. Last week, the two-year Treasury yield rose to nearly 3.75%, exceeding the Fed’s excess reserve rate, breaking a rarely breached key level.

The market indicator measuring the terminal rate — the end point of the Fed’s easing cycle — has risen about 50 basis points since late February, now above 3.4%.

Michael Gapen said, “The rise in the two-year yield surprised me a bit. I understand the long-term yields rising, but the re-pricing of the terminal rate to such a high level was indeed unexpected.”

Meanwhile, the institutional consensus is also shifting. TD Securities and Barclays both delayed their forecasts for the next Fed rate cut from June to September last week.

A key indicator: Inflation swap rates

In assessing the actual impact of the oil price shock on the economy, Morgan Stanley Global Macro Strategist Matthew Hornbach highlighted a key market indicator — the inflation swap rate.

Since crude oil prices first broke above $100 per barrel in 2022, the 1-year forward 1-year inflation swap rate has risen about 20 basis points, approaching 2.5%.

Hornbach stated that a decline in this rate would signal buying Treasury bonds and pricing in more rate cuts — shifting market focus from inflation concerns to demand destruction. He said:

“This is the most important indicator on your dashboard.”

This framework indicates that Morgan Stanley is not ignoring oil price risks but is using the trend in inflation swap rates as a core basis for dynamic adjustment — if demand signals deteriorate significantly, its rate cut forecast path will also be revised.

Although Morgan Stanley maintains its baseline forecast, Michael Gapen also clearly pointed out the downside risks: “If the Fed delays the first rate cut until September or even December, the next rate cut window could be pushed back to 2027.”

“The main risk to our view is that the longer the Fed waits, the more likely it is that additional rate cuts will be needed.”

Risk warnings and disclaimers

Market risks exist; investments should be cautious. This article does not constitute personal investment advice and does not consider individual users’ specific investment goals, financial situations, or needs. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Invest at your own risk.