Morgan Stanley Bets on Soft Landing as Fed Rate Cuts Loom

Morgan Stanley remains steadfast in its position that the U.S. economy will experience a soft landing. The firm anticipates that declining inflation levels will prompt the Federal Reserve to begin cutting interest rates as early as the September meeting.

Morgan Stanley's research team stated, "Our economists' baseline view of a resilient economy achieving a soft landing remains unchanged. They expect sustained inflation decline to drive a rate-cutting cycle, beginning with the FOMC meeting in September, and projecting three 25-basis-point cuts in 2024."

The investment bank further added, "However, until some 'good data' emerges, the market may continue to challenge the soft landing perspective (wherein the U.S. economy continues to slow but does not collapse)."

Currently, all eyes are on the upcoming July CPI report set to be released this Wednesday. An outcome in line with or below expectations would solidify the basis for anticipated rate cuts. Conversely, a higher-than-expected CPI, indicating significant inflationary pressures, could adversely impact the Federal Reserve's rate adjustment plans.

Morgan Stanley reiterated on Monday its expectation for the Fed to cut rates by 25 basis points in September, despite recent substantial declines in global markets.

The bank's economists noted that while the market reacted strongly to the latest rate decision by the Bank of Japan and weaker U.S. non-farm payroll data, these do not signify any fundamental economic shifts.

Morgan Stanley further highlighted the Fed’s dual mandate, emphasizing full employment, which has become more prominent as inflationary pressures ease. This shift supports market expectations that the Fed will adopt a more growth-focused strategy, strengthening the case for rate cuts.

According to Morgan Stanley, the U.S. economy continues to demonstrate resilience, evidenced by a 2.6% GDP growth rate and a 2.3% rise in consumer spending for the second quarter of 2024. While the unemployment rate has slightly risen to 4.3%, the labor market remains relatively healthy. These indicators suggest that the U.S. is steering towards a "soft landing" instead of a recession.

The report further asserted, "We see the economy progressing towards a soft landing. However, the market remains vigilant toward any signs suggesting a more significant economic weakening, which the data has yet to indicate."

Looking ahead, Morgan Stanley emphasized the potential interplay between Fed rate cuts and Japanese rate hikes, which may bolster the yen. Nevertheless, the initial outlook remains unchanged, and the Bank of Japan is expected to raise rates in January 2025.