Morgan Stanley Sees Disinflation Driving Fed Rate Hold

Morgan Stanley analysts say that disinflation in the US economy is driven by factors such as tariff payback, energy price relief, limited second-round effects, and moderating shelter inflation. According to the US Bureau of Labor Statistics, the headline consumer price index (CPI) rose 3.4% in July, down from 3.5% in June, while core CPI growth eased to 2.5% from 2.6%. The producer price index (PPI) also showed moderation in July.

The analysts project that the Fed will hold interest rates steady due to softer inflation and cooling employment and wage growth. They forecast a 67% probability of the Fed keeping rates unchanged next month, up from roughly 55% a week earlier. Morgan Stanley's projections suggest that if core PCE inflation slips to 3.0% year-over-year in December and 2.4% by the end of 2027, the Fed would stay on hold this year and cut its policy rate by 50 basis points next year.

However, the analysts noted that risks to their outlook skew to the upside, as they assume a full recovery from recent supply-side shocks without new shocks and limited price pressures from artificial intelligence demand. They caution that one or both of these assumptions could be wrong, leading to different outcomes for interest rates in 2027.