Interest rate cuts are back on the agenda. Currency strategists at Morgan Stanley predict a series of four consecutive 25 basis point rate interest rate reductions by the US Federal Reserve, with the federal funds rate expected to reach 3.625% by May 2025.
The bank's forecast reflects a slowdown in economic growth, cooling labor market conditions, and persistent inflationary pressures. According to Morgan Stanley, "lower immigration flows and more tariffs" are weighing on GDP growth and contributing to "stickier inflation" in the United States.
Previously, the bank's experts anticipated that US inflation would decelerate by early 2025, with the CPI remaining above the Fed’s 2% target through 2026. In addition, Morgan Stanley expected core PCE inflation to be 2.8% in 2024, falling to 2.5% in 2025 and then to 2.4% in 2026.
Analysts also forecast a significant slowdown in the US economy in the near future. The country's GDP is projected to grow by 2.4% year-on-year by the end of this year, 1.9% in 2025, and 1.3% in 2026.
According to Morgan Stanley economists, "the consumer slows" as labor income growth cools and potential tariffs keep the economy on edge. They believe that the US labor market will be negatively impacted, with unemployment expected to rise substantially. The unemployment rate is estimated to be 4.1% in 2025, climbing to 4.5% in 2026.
Morgan Stanley anticipates that the Fed will pause its rate-cutting cycle in the second half of 2026 as economic growth falls below potential. The bank also predicts that the quantitative tightening program will be unwound in early 2025.
In this regard, the global financial services firm has outlined three possible scenarios. The first involves a "hard landing," in which the Fed overtightens monetary policy, leading to a US economic contraction in 2025. The second scenario includes a "reacceleration," with rate cuts stimulating economic growth. The third scenario focuses on "Chinese reflation," in which US inflation accelerates slightly due to higher import prices.
Given the ongoing uncertainties, analysts at Morgan Stanley share the Fed’s cautious stance. "The Fed cuts 25bp in the next four FOMC meetings, taking the fed funds rate to 3.625% by May 25. Signs of stickier inflation and overall policy uncertainty lead the Fed to pause until 2H26 when rapid cuts bring rates below neutral as growth slows below potential," the bank concluded.
