Navigating the current economic landscape presents significant challenges for policymakers, particularly concerning inflation control and growth sustainability. Recent trade policy implementations under President Donald Trump are adding another layer of complexity, prompting major financial institutions to reassess their forecasts for the Federal Reserve’s monetary policy trajectory.
Morgan Stanley Revises Fed Outlook Amid Tariff Concerns
Investment bank Morgan Stanley has adjusted its projections for the Federal Reserve’s actions, citing the anticipated impact of President Trump’s tariffs. The firm now anticipates that these trade measures will fuel inflation before significantly hindering economic growth. Consequently, Morgan Stanley predicts the central bank will likely maintain its current interest rate stance throughout 2025.
The newly imposed tariffs, effective this Wednesday, are expected to affect numerous trading partners. Morgan Stanley foresees a period characterized by stubborn inflation alongside stagnant economic expansion. Their forecast points to the core Personal Consumption Expenditures (PCE) price index reaching 3.9% by the end of the year.
Inflationary Pressures to Delay Rate Cuts
According to Michael Gapen, Chief U.S. Economist at Morgan Stanley, the immediate effect of the tariffs will manifest as an uptick in inflation, with any dampening effect on economic momentum occurring later. This sequence of events complicates the Federal Reserve’s decision-making process.
“The Fed will need to wait longer before cutting,”
Gapen wrote in a note.
The Federal Reserve has held its key interest rate steady since December. Based on the expected inflationary pressures from tariffs, Gapen does not foresee any rate reductions until March 2026. Following that point, Morgan Stanley anticipates a gradual easing cycle, eventually bringing the target rate down to the 2.5%–2.75% range through a series of consecutive cuts.
Stagflation Scenario and the Recession Exception
This forecast is predicated on a baseline scenario resembling “stagflation,” where inflation remains elevated while real GDP growth slows considerably, projected at 0.8% in 2025 and 0.7% in 2026. In such an environment, the Federal Reserve’s primary focus would likely remain on price stability rather than stimulating growth through rate cuts.
However, Gapen acknowledges a significant caveat: the onset of a recession could alter this outlook dramatically. Should the economy contract, the Fed might be compelled to implement earlier and more substantial interest rate cuts to provide support. For the time being, Fed Chair Powell has emphasized a cautious approach, awaiting clearer data on the consequences of the administration’s trade policies.
This outlook from Morgan Stanley contrasts with current market sentiment, which has been pricing in several rate cuts this year. The firm joins others like Goldman Sachs in taking a more cautious stance; Goldman Sachs recently increased its probability of a recession to 45%, similarly suggesting that significant rate cuts are contingent on a serious economic downturn.
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