Morgan Stanley resets Fed interest rate cut path for 2027

Despite the bond market’s increasing expectations that the Federal Reserve will soon need to hike short-term interest rates, one major bank says the central bank will maintain holding rates steady and then resume a dovish stance next year.

Morgan Stanley’s May 18 note, shared with TheStreet, calls for two 25-basis-point rate cuts in 2027, one in March and the other in June.

“The bar for monetary easing has risen, and we expect the Fed to remain on hold through 2026 before beginning a gradual normalization cycle in 2027,’’ the note said.

The note said that despite back-to-back hot inflation reports last week and multiple forecasts that the Iran War energy shock will continue to spike prices this summer, those increases will be temporary, much like the fading impact of tariffs on prices.

“Key assumptions underpinning our core inflation outlook are that tariff passthrough will fade over the coming months and that oil spillovers into core (inflation) will remain limited,’’ the note said.

Fed has kept interest rates steady

The Federal Open Market Committee continued to hold the benchmark Federal Funds Rate -- which impacts the cost of short-term borrowing -- steady at 3.50% - 3.75% during its April 30 meeting.

But the divisive 8-4 vote among its 12 members reflected the concerns of three regional Fed presidents that rising inflation and stabilizing labor data indicated the Fed should consider tightening policy in its post-meeting statement.

The policymakers cut rates by 25 basis points at their last three meetings of 2025 to shore up the softening labor market.

The next FOMC meeting is June 16-17 and will be the first with Kevin Warsh as Chair.

President Donald Trump and other White House officials repeatedly called for the central bank to slash rates dramatically, to 1% or lower.

Warsh, who will be sworn in on May 22 in a White House ceremony, has said the Fed needs to lower interest rates and shrink its $6.7 billion balance sheet as part of a “regime change” he pledged during his Senate confirmation hearings.

Bond market ups Fed rate-hike forecast

Bond traders have been preparing for higher inflation risks since the Iran War began in late February.

And that preparation includes the possibility that the central bank will need to raise interest rates sooner than anyone expected, especially Warsh.

The CME Group FedWatch Tool raised the probability of a 25-basis-point rate hike this year to 50% to 60%, up from 40% odds last week.

The 30-year Treasury yieldtopped the 5% threshold last week, and the benchmark 10-year yield hit the 4.5% mark for the first time since June 2025.  The two-year yield rose above 4% for the first time in 11 months.