SKN | Morgan Stanley Sees Fed Holding Rates Through 2026 as Tariff Inflation Pressures Ease

Key Takeaways

• Morgan Stanley expects the Federal Reserve to keep interest rates unchanged through the remainder of 2026 before beginning gradual rate cuts in 2027.
• The bank believes tariff-related inflation pressures are fading, while the broader impact of higher oil prices on core inflation remains relatively contained.
• Morgan Stanley continues forecasting resilient U.S. economic growth supported by strong AI-driven capital spending and expanding business investment activity.

Morgan Stanley expects the Federal Reserve to maintain current interest-rate levels throughout the remainder of 2026 as inflation pressures gradually moderate across key areas of the economy.

According to the bank’s mid-year outlook, policymakers are likely to begin a gradual easing cycle during 2027 once inflation trends continue moving closer toward the Federal Reserve’s long-term targets.

Morgan Stanley analyst Michael Gapen said recent Consumer Price Index data broadly aligned with the bank’s expectations surrounding inflation normalization and economic stability.

Tariff Inflation Pressures Continue Fading

A major component supporting Morgan Stanley’s outlook is the easing impact of tariff-related inflation pressures.

The bank noted that goods categories more heavily exposed to tariffs showed slower price increases during April compared with prior months.

Morgan Stanley estimates tariffs have added roughly 64 basis points to overall price levels so far, which is close to the bank’s projected long-term impact of approximately 70 basis points.

As tariff passthrough effects continue fading, the bank expects core goods inflation to gradually normalize over time.

The moderation in goods inflation remains an important factor supporting expectations that broader inflation pressures may continue easing without requiring additional Federal Reserve tightening.

Oil Prices Push Headline Inflation Higher

Higher oil prices continue contributing to elevated headline inflation levels, particularly through rising gasoline prices.

Morgan Stanley noted that gasoline prices increased for a second consecutive month, helping maintain upward pressure on headline inflation data.

However, the bank believes spillover effects into broader core inflation categories remain relatively limited.

Airfares were identified as one of the few areas showing clearer acceleration tied to higher energy costs, while most core inflation components remain comparatively stable.

This distinction between headline energy-driven inflation and broader core inflation trends remains central to Morgan Stanley’s expectation that the Federal Reserve can remain patient on future policy adjustments.

U.S. Growth Outlook Remains Resilient

Despite ongoing inflation concerns and geopolitical uncertainty, Morgan Stanley continues forecasting relatively stable U.S. economic growth.

The bank projects real GDP growth of approximately 2.3% during 2026 and 2.6% during 2027.

Morgan Stanley acknowledged that higher energy prices are likely to place some pressure on consumer spending, particularly among lower- and middle-income households.

Real consumption growth is expected to remain more moderate as rising living costs and fuel prices weigh on discretionary spending activity.

AI Investment Continues Driving Economic Expansion

One of the strongest growth drivers in Morgan Stanley’s forecast remains business investment tied to artificial intelligence infrastructure and technology expansion.

The bank expects AI-related capital expenditures to continue accelerating, helping support nonresidential investment growth of approximately 7% to 8%.

Hyperscaler technology spending alone is projected to exceed $1 trillion by 2027 as major cloud and technology companies continue expanding AI-focused infrastructure.

This ongoing AI investment cycle continues serving as one of the most important supports for broader U.S. economic activity despite pressure on portions of the consumer economy.

Labor Market Remains Stable

Morgan Stanley described the U.S. labor market as maintaining a “curious balance,” where moderate hiring growth remains sufficient to keep unemployment relatively stable.

The bank expects monthly payroll gains of approximately 50,000 to 60,000 jobs to gradually push unemployment toward roughly 4.1% by 2027.

While labor-market conditions are cooling somewhat compared with prior years, Morgan Stanley does not currently view employment conditions as weak enough to force aggressive near-term monetary easing.

Inflation Forecast Continues Improving

Morgan Stanley forecasts core personal consumption expenditures inflation easing toward approximately 2.8% to 2.9% during 2026 before declining further to around 2.3% in 2027.

The bank expects the terminal federal funds rate to eventually settle within a range of approximately 3.0% to 3.25%.

This outlook suggests policymakers may ultimately be able to gradually normalize rates without triggering a major economic downturn if inflation trends continue improving.

Outlook

Looking ahead, investors will likely remain focused on inflation data, labor-market trends, energy prices, and the pace of AI-related business investment.

Morgan Stanley’s outlook suggests the Federal Reserve may remain patient throughout 2026 as tariff-related inflation pressures fade and core inflation gradually moderates.

At the same time, continued strength in AI infrastructure spending and corporate investment activity may help offset softer consumer demand and support broader economic resilience.

For confidential insights on Federal Reserve policy, inflation trends, and global macroeconomic developments, connect with the SKN team for professional engagement