Late-night shockwave! Is the Fed’s “nuclear bomb” countdown for a fall rate hike imminent? Morgan Stanley sharply pushed back: no rate hikes at all this year. Deutsche Bank warned that balance sheet reduction is what turns the US dollar into a “meat grinder.”

Friend, have you also been confused by the news from the Federal Reserve recently? On one side, gasoline prices have plunged and employment data look weak, so it seems like the pressure to raise rates should ease. On the other side, former New York Fed chair Dudley—this old guy—jumps in and says, don’t get too happy yet; by autumn, the pressure to raise rates will come crashing down like an avalanche.

Let me walk you through the data first: in June, gasoline prices fell sharply, and core inflation cooled too; non-farm payrolls added only 57k jobs, less than half of expectations, and the figures for the prior two months were revised down by 74k. This looks like a signal for “no rate hikes,” right? But Dudley gave four reasons—each one hits hard.

First, the unemployment rate is hovering at the level consistent with full employment, but core inflation is still stuck between 2.4% and 3.3%, creating a mismatch of the dual goals—so restrictive monetary policy is necessary to fix it. Second, the federal funds rate has already been at a high level for four years; the unemployment rate hasn’t budged, and the financial conditions are so loose they feel like early 2022 when rates were near zero—the Fed’s tightening hasn’t caused any meaningful harm at all. Third, the AI industry’s expansion is driving up electricity and chip prices, and near-term inflation pressures haven’t really let up. Fourth, inflation has stayed above 2% for five consecutive years, eroding the Fed’s credibility—if they act even slower, markets will doubt whether the “hawkish” statements from Waller are just talk.

The market is currently pricing in the idea that the FOMC will hold steady next week, but Dudley thinks that by autumn the pressure to raise rates will fully explode.

Morgan Stanley’s chief U.S. economist Michael Gapen took the opposite view outright: no rate hike once for the whole year; in 2027, inflation falling is what would lead to two rate cuts. He’s more optimistic, and his reasons are also hard-edged: the transmission of tariffs to end prices is close to the finish line, and rental inflation is cooling; geopolitical tensions involving Iran ease, and Brent crude fell below $70 by late June—Morgan Stanley expects oil prices by end-2027 to be about $70 as well; weak employment data combined with prior downward revisions clearly signals cooling labor demand.

Morgan Stanley’s rate-strategy analyst Martin Tobias also built a 12-item financial conditions index based on market indicators. The result shows that since the Iran conflict erupted, the degree to which markets have tightened on their own is already equivalent to four 25-basis-point rate hikes; forward rates have already priced in inflation risk, so the Fed doesn’t need to add more with delayed data.

Also, after Waller substantially trimmed forward guidance, the impact of inflation and employment data on market expectations will be amplified, volatility in short-term rates will increase, and the value of medium- to short-duration bond allocation will stand out.

George Saravelos from Deutsche Bank warned from a different angle: if the Fed switches to balance-sheet reduction instead of rate hikes, the dollar will keep weakening. The current balance sheet is $6.7 trillion, down quite a bit from the $9 trillion peak in September 2022. He used Japan’s central bank’s balance-sheet reduction as an example—when the BOJ accelerated the reduction of its holdings of government bonds, the yen actually fell to a 40-year low. It shows that balance-sheet reduction without short-term rate support can’t save the currency at all.

More importantly, balance-sheet reduction conflicts with the goal of the U.S. suppressing long-term bond yields. Saravelos said plainly that the Fed’s Treasury holdings aren’t unusually large, and balance-sheet reduction is not an effective tool for governing inflation. But if the Fed decides to shift its focus from rate hikes to balance-sheet reduction, that would be an unambiguous bearish signal for the dollar.

In plain terms, in this standoff, you may be watching every move the Fed makes—but what truly determines the fate of your position is the logic clash behind these institutions. Dudley represents an old-school hawkish camp; Morgan Stanley represents a data-driven optimist camp; and Deutsche Bank is watching the hidden line in the balance sheet.

For people in the crypto circle, a weakening dollar means less pressure on risk assets, and replacing rate hikes with balance-sheet reduction could also create expectations of looser liquidity. But don’t forget: inflation running persistently above target is the bigger gray rhino.

Look, even these smartest minds in the world are arguing like this—are you holding your trades tight?

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