Morgan Stanley Stands Firm on Rate Forecast Despite Hot CPI Report

The latest Consumer Price Index (CPI) report showed inflation running hotter than expected, sending Treasury yields higher and prompting a market-wide reassessment of Federal Reserve rate cut expectations. However, Morgan Stanley remains steadfast in its view that the Fed will cut rates just once in 2025, maintaining its forecast for a single reduction in June.

While some investors anticipated that stronger inflation data might prompt a more hawkish stance from the Federal Open Market Committee (FOMC), Morgan Stanley’s outlook reflects a belief that inflation pressures will moderate over the coming months. This measured approach contrasts with market sentiment, which had been pricing in a more aggressive rate-cutting cycle earlier in the year.

Interpreting the Hot CPI Print

The January CPI report revealed a 3.3 percent year-over-year increase in core inflation, slightly above the expected 3.2 percent and an uptick from December’s reading. This unexpected acceleration raised concerns that inflation might be stickier than anticipated, delaying the Fed’s ability to begin cutting rates.

Morgan Stanley acknowledges the strong CPI data but suggests that the implications for the Fed’s preferred inflation measure—the core Personal Consumption Expenditures (PCE) index—will likely be less pronounced. The firm anticipates that core PCE will show a gradual decline in annualized inflation throughout the first quarter of 2025.

Why Morgan Stanley Expects Just One Rate Cut

Despite the market’s initial reaction to the CPI report, Morgan Stanley is not revising its forecast for the Fed’s policy trajectory. The firm maintains the following key arguments for its outlook:

1. Core PCE Inflation Remains on a Downward Path

While CPI showed unexpected strength, Morgan Stanley believes that the core PCE index—a key metric that the Fed watches more closely—will continue to ease. The firm expects a softer reading for January’s core PCE compared to the previous month’s print, reinforcing a trend of gradual disinflation.

2. The Fed’s Commitment to Caution

Federal Reserve Chair Jerome Powell has consistently emphasized the need for sustained confidence that inflation is moving toward the 2 percent target before considering rate cuts. With economic data remaining mixed, Morgan Stanley expects the Fed to extend its policy pause rather than move aggressively to lower rates.

3. One Cut is Enough to Balance Growth and Inflation

The firm’s June rate cut projection is based on the belief that economic conditions will warrant some easing, but not an aggressive series of reductions. With inflation proving resilient and the labor market still relatively strong, a cautious approach will allow the Fed to balance the risk of reigniting price pressures against the need to support economic growth.

Market Reactions and Investor Implications

Following the release of the CPI data, bond markets adjusted to reflect a diminished likelihood of near-term rate cuts. Treasury yields climbed sharply, with the 10-year yield rising to 4.64 percent, reflecting reduced expectations for an early Fed pivot.

Equities, meanwhile, experienced a mixed reaction. While tech-heavy indices such as the Nasdaq found support from large-cap growth stocks, broader market sentiment remained cautious. The prospect of higher-for-longer interest rates weighed particularly on rate-sensitive sectors such as real estate and consumer discretionary.

For investors, Morgan Stanley’s outlook suggests a more patient approach to interest rate expectations. While some segments of the market have been pricing in a more dovish Fed stance, this latest inflation reading underscores the importance of monitoring core PCE data and labor market trends.

Looking Ahead: Key Data to Watch

Given the evolving economic landscape, several upcoming reports will be critical in shaping Fed expectations:

- Core PCE Inflation Report (February 29, 2025)

The next reading of the Fed’s preferred inflation measure will provide further clarity on the trajectory of price pressures. A softer-than-expected print could reinforce the case for a mid-year rate cut.

- FOMC Meeting (March 19-20, 2025)

The Fed’s next policy meeting will offer fresh guidance on its economic outlook and potential rate path. While no immediate changes are expected, any shifts in Powell’s language could signal evolving views within the central bank.

- March Jobs Report (April 5, 2025)

Labor market strength remains a key factor in the Fed’s decision-making process. Any signs of softening employment conditions could increase pressure for a policy adjustment.

Final Thoughts

Morgan Stanley’s decision to hold firm on its rate forecast reflects confidence that the Fed will remain measured in its approach to monetary policy. While the latest CPI report fueled speculation that rate cuts might be further delayed, the firm continues to anticipate only a single rate reduction in June.

For investors, this outlook suggests the need for a balanced approach to portfolio positioning. With rate expectations in flux and inflation uncertainty persisting, maintaining flexibility and diversification will be crucial in navigating the evolving market landscape.