Morgan Stanley reiterated its baseline expectation that the Federal Reserve will keep interest rates on hold for the rest of the year, although the market now almost certainly expects a rate cut in September.
In a note on Monday, the bank’s analysts said the Consumer Price Index (CPI) data for July showed an increase as expected but with a different composition. “Goods remained firm as expected, but did not increase. In contrast, services inflation showed a surge,” they explained.
Morgan Stanley stressed that tariff-sensitive goods continued to post strong prices, but the surprise came from services inflation such as airfares and hotel prices rebounding after months of deflationary pressures.
Analysts also cautioned that core CPI inflation (3.1% year-on-year estimate for July) and core PCE inflation (2.9% y/y forecast) are still at the same pace as last year. If the impact of tariffs causes a surge in goods over the summer, inflation would still remain well above the Fed’s 2% target.
The August jobs report will be a critical factor. If job growth picks up and the unemployment rate remains around 4.2–4.3%, the Fed is likely to ignore the weakness in the May and June data. However, if hiring declines sharply, the Fed may consider the labor market weaker than expected and resume easing monetary policy even though inflation remains high. Morgan Stanley also added that a rate cut is likely to remain in place due to global risk management factors.
