Morgan Stanley Sees Disinflation but Warns of Upside Risks to Interest Rate Projections

Morgan Stanley says disinflation is present in the US economy, but there are still risks to its interest rate projections for 2027. The inflation reports from this week showed a moderation in price pressures on an annual basis, prompting traders to pare expectations of Federal Reserve rate hikes.

The data confirmed Morgan Stanley's outlook of disinflation, with headline U.S. consumer price index (CPI) growth slowing to 3.4% in July and core CPI growth moderating to 2.5%. The producer price index (PPI) also moderated in July, indicating some breathing room for the Fed to keep interest rates on hold.

Morgan Stanley analysts noted that disinflation is driven by tariff-payback, energy-price relief, and limited second-round effects, as well as moderating shelter inflation. They expect the Fed to stay on hold through year-end due to softer inflation alongside cooling employment and wage growth.

However, the analysts also highlighted risks to their monetary policy outlook skewed to the upside. They assume a full recovery from recent supply side shocks without the emergence of a new shock and limited price pressures related to artificial intelligence demand. One or both of these assumptions could be wrong, leading to potential rate hikes or cuts.