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Investing.com - Morgan Stanley now expects the Federal Reserve to slash interest rates by a full percentage point through January, as policymakers look to address a weakening labor market and softer-than-anticipated underlying inflation.
In a note to clients on Friday following the release of the August consumer price index earlier this week, the analysts led by Michael Gapen said the "risks to the labor market have risen," highlighting weak payrolls and a fading rate of open roles.
"Recent data warrant faster cuts" toward the Fed’s so-called neutral rate, a theoretical level where borrowing costs neither help nor hinder economic activity, the Morgan Stanley analysts argued. Rates have recently been elevated after a period of rapid increases in 2022 and 2023 aimed at corralling a post-pandemic spike in inflation.
The Fed began to slash rates from these heights near the end of last year, but pushed pause on its easing cycle in December. It has left rates unchanged ever since, with officials partially citing worries that sweeping U.S. tariffs could drive up prices.
Although some major businesses have flagged that price hikes have already arrived, the impact of the levies on the August CPI reading was "less pronounced," the Morgan Stanley analysts said. The measure stood at 0.4% month-on-month, compared to 0.2% in July and economists’ estimates of 0.3%.
Separately on Thursday, weekly initial jobless claims ticked up to nearly a four-year high, further underlining a slowdown in the U.S. labor market. This came after the employment report for August also fell well short of expectations.
The prospect of a cooling jobs picture is firing bets that the Fed will slash rates from the current target range of 4.25% to 4.5% at its September 16-17 meeting. Cutting borrowing costs could boost investment and hiring, yet risk pushing up inflation.
Against this backdrop, the Morgan Stanley analysts said they now anticipate that the Fed will reduce rates by 25 basis points next week and at its following three gatherings through January. Another two drawdowns of similar size are seen in April and July of 2026 as well.