Morgan Stanley has updated its baseline forecast for the Federal Reserve, maintaining the view that interest rates will remain unchanged through the end of 2026. However, the bank's analyst Michael Gapen warned that the outlook could shift toward rate hikes if the U.S. unemployment rate falls below 4% or if inflation remains persistently high.
According to a client note, data since the June FOMC meeting has tentatively supported the 'no rate hike' scenario. Gapen pointed to expected declines in oil prices following a U.S.-Iran memorandum of understanding, and the peak pass-through effect of tariffs on inflation. The bank projects headline PCE inflation at 3.2% and core PCE at 3.0% for Q4 2026, both significantly below the median FOMC member expectations.
On the labor market, Morgan Stanley forecasts 50,000–60,000 new jobs per month during the summer, enough to keep the unemployment rate roughly flat. However, if unemployment dips below 4.0%, the Fed could view the labor market as overheated — justifying a rate increase. The outlook would also be reassessed if monthly core inflation stays at or above 0.3%, or if Middle East tensions escalate further.
