Morgan Stanley Sees Two Fed Hikes as Markets Prepare for One
The Federal Reserve's upcoming decision has markets preparing for a quarter-point interest-rate increase. However, Morgan Stanley believes investors are fixating on this week's event and overlooking what comes next.
The bank now predicts two rate hikes in September and December, indicating a more hawkish policy path that would transform the current move from an isolated response to inflation into the beginning of renewed tightening.
The possibility of multiple rate hikes is gaining traction as oil prices climb above $100 a barrel and Treasury yields rise. The 10-year yield has surpassed 5% for the first time since 2007, while markets assign a 93% probability to this week's quarter-point Fed increase.
Morgan Stanley's economists warn that the US disinflation process is slowing down and may not be convincing enough for policymakers. They cite potential second-round effects from high energy costs, strong demand driven by AI-related investment, a potentially higher neutral interest rate, and the need to preserve the Fed's inflation-fighting credibility.
Treasury yields are starting to signal a similar story. Padhraic Garvey, ING's head of Americas research, notes that the gap between the two-year Treasury yield and the current Fed funds rate has approached 90 basis points, surpassing the historical threshold of 75 basis points preceding a rate increase.