Morgan Stanley: The Federal Reserve Still Expected to Cut Rates as Early as June, but a "Later and More Aggressive" Move Is Also Possible!

Morgan Stanley indicates that the Federal Reserve may restart rate cuts as early as June, but the oil price shock triggered by the Iran conflict could delay this process.

The bank’s economists currently maintain their previous forecast, expecting the Fed to cut rates by 25 basis points in June and September this year—despite rising energy prices potentially intensifying inflationary pressures. However, they also believe the Fed might delay its first rate cut until September or even December, with both scenarios possibly pushing the next cut into 2027.

Morgan Stanley Chief U.S. Economist Michael Gapen and colleagues stated in a report on Wednesday: “If the Fed learns from history and implements an easing policy earlier than expected due to inflation pressures from oil prices, then we believe the current position is advantageous.”

Since the beginning of this month, U.S. and Iran attacks have caused oil prices to surge sharply, triggering market turbulence. This has cast a shadow over when the Fed might resume easing—futures markets currently price in only one 25 basis point cut this year, most likely at the October meeting.

Although Trump has recently claimed multiple times that the war with Iran will “end soon,” and the International Energy Agency agreed on Wednesday to release a record 400 million barrels from emergency reserves, oil prices remain high, with Brent crude trading above $90 per barrel.

Morgan Stanley economists pointed out that if oil prices fail to return to pre-war levels, overall inflation pressures in 2026 will intensify, and the unemployment rate will continue to rise into late 2028. Before Trump initiated the war, oil was about $70 per barrel.

“The Fed will balance its dual mandate (price stability and full employment) through a more aggressive easing policy than originally planned,” Gapen and colleagues said. “Therefore, the second risk to our monetary policy outlook is: the Fed may delay rate cuts but implement them more forcefully.”

Morgan Stanley economists added, “We believe current market pricing reflects both increased uncertainty about the duration of the conflict and the market’s understanding that the Fed’s response will become clearer only as data and time evolve.”

In the bond market, the yield on the two-year U.S. Treasury rose to a five-month high on Wednesday, driven by rising oil prices and inflation concerns, delaying expectations of Fed rate cuts. Traders largely ignored the February CPI data, which aligned with economists’ forecasts.

On Wednesday, the IEA agreed to release 400 million barrels from reserves, the largest such move in its history, aiming to curb the surge in crude prices caused by supply shocks from the U.S.-Iran conflict.

Latest pricing in federal funds rate futures shows that expectations for rate cuts by the Fed before year-end have narrowed to 32 basis points—closer to a single 25 basis point cut—down from 41 basis points on Tuesday, indicating market expectations for two 25 basis point cuts this year are continuing to weaken.