Morgan Stanley: Expect the Federal Reserve to delay interest rate cuts, but the easing could be larger to balance the dual mandate

Morgan Stanley believes that the oil price shock may delay the Federal Reserve’s next rate cut. If oil prices fail to return to pre-conflict levels, the overall inflation impact by 2026 will be greater, and to balance inflation and the economy, the Fed may cut rates more significantly.

Morgan Stanley states that the Fed could resume rate cuts as early as June, but the oil price shock triggered by the Iran war may postpone the next cut.

Although rising energy prices could exacerbate inflation, Morgan Stanley economists still maintain their previous forecast of two rate cuts this year, in June and September, each by 25 basis points.

However, they believe the Fed might delay the first rate cut until September or even December, both scenarios potentially pushing the second cut into 2027.

Media quoted Morgan Stanley Chief U.S. Economist Michael Gapen and his team in a report on Wednesday: “If the Fed learns from historical experience and ignores the price pressures caused by rising oil prices, and implements easing prematurely, then we believe we are in a favorable position.”

The attacks by the U.S. and Israel on Iran sharply pushed up oil prices and caused market turbulence. This has raised concerns about when the Fed will next implement monetary easing, with futures markets currently expecting only a 25 basis point cut this year, most likely at the October meeting.

Early Thursday morning Hong Kong time, oil prices surged again to nearly $100. Despite Trump’s recent multiple statements that the war with Iran will “end soon,” and the International Energy Agency’s agreement on Wednesday to release a record 400 million barrels from emergency reserves, oil prices remain high.

Morgan Stanley economists say that if oil prices fail to return to pre-conflict levels, by 2026, the overall inflation impact will be greater, and the unemployment rate will remain slightly elevated until the end of 2028.

Michael Gapen and his team stated that the Fed will balance its dual mandate with a larger easing than previously planned. Therefore, the second risk to monetary policy outlook is that the Fed’s rate cuts may be delayed, but the magnitude of cuts could be larger.

“We believe that the current market pricing reflects high uncertainty about the duration of the conflict, and people recognize that the Fed’s response will only become clearer over time and with data.”