Morgan Stanley makes major change to Fed interest rate cut forecast

Morgan Stanley has changed its forecast regarding a potential Federal Reserve interest rate cut next month.

In a note dated Aug. 26, Morgan Stanley Chief Economist Michael Gapen joined a growing trend of global brokerages changing forecasts.

This is due to Fed Chair Jerome Powell's recent shift in tone toward rising labor market risks.

Powells Jackson Hole remarks signal a change in his view

Powell opened the door to possible future Fed interest rate cuts on Aug. 22. At the same time, he underscored current economic risks and uncertainty that must be considered before the policy-making Federal Open Market Committee acts when it meets on Sept. 16-17.

Powell's speech was closely watched by global policymakers and investors for any hint of the Feds next step.

The last time the FOMC cut the benchmark Federal Funds Rate was in December.

It has held rates steady at 4.25% to 4.50% in a “wait-and-see” approach, which opponents have said doesnt reflect increasing weakness in the labor market.

Powell cited “sweeping changes” in tax, trade, and immigration policies in the Jackson Hole speech.

The result is that “the balance of risks appears to be shifting” between the Feds twin goals of full employment and stable prices under its dual mandate.

Powell said tariffs are causing risks that could cause inflation to rise again. This, he said, is a stagflation scenario that the Fed needs to avoid.

President Donald Trump has been extremely critical of the Fed, and Powell in particular.

The president and his allies have been calling for a steep cut in rates for several months.

Morgan Stanley‘s note focused on Powell’s shift in tone

Gapens note said Powell's tone marked a departure from his earlier emphasis on inflation persistence and low unemployment, suggesting the Fed may move to manage risks to the labor market.

Morgan Stanley now forecasts two 0.25% cuts in 2025 to the Federal Funds Rate.

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One would come in September, the other in December.

Morgan Stanley also forecast quarterly 0.25% interest rates in 2026, bringing the benchmark interest rate to 2.75% to 3.0%.

That's a shift from its previous view that the central bank would stay on hold until March 2026 and cut more aggressively thereafter.

Powells shift felt around the world

Powell's remarks triggered a wave of revised forecasts across brokerages, with Barclays, BNP Paribas, and Deutsche Bank expecting a 0.25% cut next month.

Traders now expect an 87.3% chance of a September cut of 0.25%, according to the CME Groups widely watched FedWatch Tool.

The change in forecasts reflect what the economists called a shift in the Fed's “reaction function,” with Powell now appearing more sensitive to labor market deterioration than before, Reuters reported.

“A large up-front cut would come only with sizable payroll declines,” Morgan Stanley noted, referring to cuts bigger than 0.25%. “The Fed may also see dissents against rate cuts in September.”

BofA Global Research remains the only major brokerage still forecasting no rate cuts this year.

President Trump seeks more executive control over the Fed

The Trump administration's effort to steer the Fed towards more aggressive rate cuts has intensified with the president announcing plans to fire Governor Lisa Cook over alleged mortgage fraud.

Cook, the first Black woman to serve on the Feds seven-member Board of Governors, has said she will not leave her role and will fight the dismissal in court.

JPMorgan analysts, in a separate note, warned the move could open vacancies on the Fed Board of Governors and potentially shift the balance of power within the FOMC.