After a close look at Warsh, Morgan Stanley’s chief economist insists that the Federal Reserve will not raise interest rates this year.

Author: Zhao Ying

The policy stance of new Federal Reserve Chair John Williams (Walsh) is under close scrutiny by the market. Morgan Stanley Chief Global Economist Seth Carpenter, writing after attending the European Central Bank's annual conference in Sintra, Portugal, pointed out that based on employment data, inflation forecasts, and policy signals, the Federal Reserve will not raise interest rates this year.

In his report, Carpenter wrote that Walsh's remarks at the Sintra Policy Forum continued the tone of his inaugural press conference — a strong commitment to price stability, but deliberately avoiding the specific path to achieve this goal. Carpenter noted two noteworthy changes:

First, Walsh's phrasing on the dual mandate has become more balanced, shifting from an almost singular focus on inflation to a more explicit acknowledgment of the full employment goal;

Second, Walsh particularly emphasized that the most recent policy meeting (coupled with falling oil prices) has lowered market inflation expectations and term premiums. This statement led Carpenter to believe that a rate hike by the Fed in July is unlikely.

Against the backdrop of uncertainty over the Fed's policy path, Morgan Stanley maintains its baseline forecast of no rate hikes for the full year, meaning the market does not need to price in near-term rate hike risks.

Walsh's Sintra Signal: Balancing the Dual Mandate, Downplaying Urgency of Rate Hikes

Carpenter personally witnessed Walsh's speech at the Sintra Policy Forum and interpreted it as a marginally dovish shift. He noted that Walsh had previously left the market with the impression that price stability was an overwhelming priority, but this speech more clearly incorporated full employment into the policy framework.

More importantly, Walsh proactively pointed out that the policy meeting had pushed down market inflation expectations and term premiums, and mentioned that several "working groups" are being formed and will take time. Carpenter believes that this combination of wording sends a clear signal: the Fed is not in a hurry to act in July.

Data Supporting Patience: Inflation Forecasts Below FOMC Median, Nonfarm Payrolls Provide Buffer

At the fundamental level, Carpenter cited several factors supporting the forecast of no rate hikes. The nonfarm payroll data released last week continues to provide room for the Fed to stay put. Meanwhile, Morgan Stanley's inflation forecasts are significantly lower than the median forecast of FOMC members, and there is a possibility of further significant downward revisions to inflation readings due to methodological revisions to PCE inflation.

Carpenter said that the combination of these factors makes him "comfortable" with his judgment of no rate hikes for the full year. Data could certainly change the conclusion, but the current evidence points in the same direction.

AI and Productivity: Not Simply a Bet on Rate Cuts

Carpenter also discussed the impact of artificial intelligence on monetary policy and questioned the popular narrative that "AI will bring deflation and drive rate cuts." He pointed out that the wave of AI capital spending arrived earlier and on a larger scale in the U.S., with a marginal upward effect on inflation in the short term.

More importantly, he raised three counterarguments: First, the state of the business cycle will dominate policy direction; second, the deflationary effect is just one of many impacts; higher productivity will also boost demand through consumption and investment; third, faster productivity growth implies a higher equilibrium interest rate (what economists call r*), further weakening the logic for rate cuts. Carpenter stated bluntly that the simple assertion that AI will inevitably lead to rate cuts is "almost certainly wrong."

ECB Policy Divergence: Possibly Another 25bp Hike in September, but Soft Data Leaves Room for Variables

In contrast to the Fed, the European Central Bank's policy direction is more clearly tilted toward tightening. Carpenter noted in the article that ECB President Christine Lagarde reiterated at Sintra that the June rate hike was a carefully considered decision, not merely a "precautionary hike," which in his view implies room for further rate hikes.

Morgan Stanley's baseline forecast is for the ECB to raise rates by another 25 basis points in September. However, Carpenter also pointed out that last week's soft European inflation data and the sharp drop in oil prices leave room for policy flexibility — if inflation continues to soften or PMIs weaken significantly, the path for another rate hike could be blocked. He believes that a rate hike in July or more than one hike within the year is currently difficult to imagine.