Morgan Stanley Sees Fed Holding Rates as U.S. Inflation Cools

U.S. inflation showed further signs of easing in July, strengthening expectations that the Federal Reserve could keep interest rates unchanged through the end of the year. Morgan Stanley believes the latest inflation data supports its disinflation outlook, although lingering price risks could influence Fed policy in 2027.

According to the U.S. Bureau of Labor Statistics, annual headline consumer price index (CPI) inflation slowed to 3.4% in July from 3.5% in June. Core CPI, which excludes volatile food and energy prices, eased to 2.5% from 2.6%. Producer price index (PPI) measures also moderated during the month.

Combined with a weaker-than-expected July nonfarm payrolls report, the softer inflation figures give the Federal Reserve more flexibility to maintain its current monetary policy while assessing incoming economic data. CME FedWatch data showed traders placing roughly a 67% probability on the Fed holding rates steady at its next meeting, up from around 55% a week earlier.

Morgan Stanley analysts led by Michael Gapen attributed the disinflation trend to easing energy prices, moderating shelter inflation and the fading impact of tariffs. Cooling employment and wage growth could further support a Fed pause through year-end.

The bank now forecasts July core personal consumption expenditures (PCE) inflation at 0.23% month over month and headline PCE at 0.14%. On an annual basis, Morgan Stanley expects the measures at 3.27% and 3.64%, respectively.

Under its baseline forecast, core PCE inflation could fall to 3.0% by December and 2.4% by the end of 2027. That scenario would see the Fed hold interest rates steady this year before delivering two 25-basis-point rate cuts in March and June next year.

However, Morgan Stanley warned that inflation risks remain tilted to the upside. Persistent supply-side pressures or stronger price effects from artificial intelligence-related demand could delay rate cuts. If disinflation stalls or inflation accelerates again, the Fed could even consider 50 to 75 basis points of additional rate hikes.

For now, Morgan Stanley expects continued progress toward the Fed’s 2% inflation target, with patience remaining the central bank’s most likely approach.