Morgan Stanley economists confirmed that the Federal Reserve (Fed) is now shifting its macro assessment axis to make “hard inflation” its top policy priority. A strategic note released on Friday revealed that the continued strengthening of the domestic labor market has successfully reduced the risk of an economic downturn, thus giving the central bank room to focus on curbing the cost of living chain.
According to Michael Gapen and Sam Coffin, the outlook for a decline in US inflation in the second half of 2026 is now entirely focused on the geopolitical dynamics of the war in the Middle East. Since the armed conflict erupted in late February, Iran’s blocking of commercial tanker routes in the Strait of Hormuz has triggered a global petroleum and LNG supply shock that has affected the cost structure of the industry.
This week’s economic data reports evidenced the impact of the maritime war, with headline consumer inflation (CPI) in May jumping sharply to 4.2% while wholesale PPI inflation rose to 6.5%. The high energy cost chain has forced Wall Street economists to revise up their latest Core PCE data estimates, which serve as the Fed’s official gauge of the cost of borrowing US dollars.
Given the reality that the labor market remains immune to the threat of an economic recession, futures markets expect the FOMC committee to opt for a status quo decision at next week’s policy meeting. Investors’ initial expectations at the beginning of 2026 that the Fed would launch a series of aggressive interest rate cuts have now been officially erased from the international commercial bond market.
However, Morgan Stanley warned that capital markets should prepare for a longer phase of monetary tightening. If household retail purchasing power rebounds as a result of the adoption of AI technology, or if the risk premium for Brent crude oil remains high due to the failure of Trump’s draft peace plan, the Fed is expected to not hesitate to activate a series of interest rate hikes before the end of December.
