Morgan Stanley has projected that the Federal Reserve will reduce interest rates by 25 basis points (bps) during each of the next four Federal Open Market Committee (FOMC) meetings, lowering the federal funds rate to 3.625% by May 2025.
The forecast is based on expectations of slower economic growth, a cooling labor market, and inflationary pressures that remain persistent. According to Morgan Stanley, factors such as reduced immigration and increased tariffs are contributing to slower GDP growth and more persistent inflation trends.
While inflation is expected to ease by early 2025, Morgan Stanley predicts it will remain above the Fed’s 2% target until at least 2026. The firm forecasts core PCE inflation at 2.8% for 2024, 2.5% for 2025, and 2.4% for 2026.
The bank also anticipates a significant slowdown in economic growth, with GDP growth expected to drop from 2.4% in 2024 to 1.9% in 2025, and further to 1.3% in 2026 on a year over year basis. Labor market conditions are also projected to soften, with unemployment rising from 4.1% in 2025 to 4.5% by the end of 2026.
Morgan Stanley suggests the Fed may pause rate adjustments in the latter half of 2026 as economic growth falls below its potential. Quantitative tightening (QT) is expected to conclude by early 2025.
In addition to this baseline projection, the bank outlined three alternative scenarios:
- Hard Landing: Over-tightening by the Fed leads to a GDP contraction in 2025.
- Reacceleration: Rate cuts stimulate stronger economic growth.
- China Reflation: Rising import costs from China push inflation slightly higher.
Despite these varying possibilities, Morgan Stanley stressed the Federal Reserve’s cautious approach, summarizing: “The Fed is expected to implement four 25bps cuts, reducing the fed funds rate to 3.625% by May 2025. Afterward, signs of persistent inflation and policy uncertainty could result in a pause until the latter half of 2026, when further rate reductions may be needed as growth slows below its potential. QT is expected to conclude by early 2025.”
This outlook reflects a complex economic environment as the Fed navigates multiple challenges to achieve stable growth and inflation targets.
