Morgan Stanley's chief economist insists: The Fed will not raise interest rates this year.

Author: Zhao Ying, Wall Street

Federal Reserve Chair Walsh's policy stance is under close market scrutiny. Morgan Stanley Chief Global Economist Seth Carpenter, writing after attending the European Central Bank's Sintra conference in Portugal, noted that based on employment data, inflation forecasts, and policy signals, the Fed will not raise rates this year.

Carpenter wrote in his report that Walsh's remarks at the Sintra policy forum echoed the tone of his inaugural press conference—a strong commitment to price stability, but a deliberate avoidance of the specific path to achieve this goal. Carpenter observed two notable changes:

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

• Second, Walsh specifically emphasized that the most recent policy meeting (combined with falling oil prices) had lowered market inflation expectations and term premiums—a statement that led Carpenter to believe a July rate hike by the Fed is unlikely.

With uncertainty surrounding 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 risk.

Walsh's Sintra Signal: Balancing the Dual Mandate, De-emphasizing Rate Hike Urgency

Carpenter attended Walsh's policy forum speech in Sintra 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 critically, Walsh proactively pointed out that the policy meeting had pushed down market inflation expectations and term premiums, and mentioned that multiple "working groups" are being formed and will take time. Carpenter believes 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 cites several factors supporting the no-rate-hike forecast. Last week's nonfarm payroll data continues to provide room for the Fed to hold steady. Meanwhile, Morgan Stanley's inflation forecasts are significantly lower than the median projections of FOMC members, and there is potential for further substantial downward revisions to PCE inflation due to methodological changes.

Carpenter says these factors, taken together, make him "comfortable" sticking with his forecast of no rate hikes for the full year. Data could certainly change the conclusion, but current evidence points in the same direction.

AI and Productivity: Don't Simple-Mindedly Bet on Rate Cuts

Carpenter also discussed the impact of artificial intelligence on monetary policy, questioning the popular narrative that "AI will bring deflation and drive rate cuts." He noted that the wave of AI capital expenditure has occurred earlier and on a larger scale in the U.S., with a marginal upward effect on inflation in the near term.

More importantly, he offers three counterpoints: First, the state of the business cycle will dominate policy direction; second, the deflationary effect is just one among many influences—higher productivity also boosts demand through consumption and investment; third, faster productivity growth implies a higher equilibrium interest rate (what economists call r*), further weakening the case for rate cuts. Carpenter states bluntly that the simplistic assertion that AI inevitably leads to rate cuts is "almost certainly wrong."

ECB Path Divergence: Possibly Another 25bp in September, but Soft Data Leave Room for Variability

In contrast to the Fed, the ECB's policy direction is more clearly tilted toward tightening. Carpenter notes in his article that ECB President Lagarde reiterated in Sintra that the June rate hike was a well-considered decision, not merely a "precautionary hike"—a statement that, in his view, implies further room for rate increases.

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