Does High Oil Prices "Dampen" Fed Rate Cut Expectations? Morgan Stanley Insists: First Cut in June, Two More to Come!

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Source: Cailian Press

Cailian Press, March 17 — (Editor: Huang Junzhi) As the US-Iran conflict keeps oil prices high and ignites inflation concerns, the Fed rate cut expectations on Wall Street are also rapidly cooling. However, Morgan Stanley still maintains its original forecast that the Federal Reserve will resume rate cuts in June and cut again in September.

Morgan Stanley Chief U.S. Economist Michael Gapen said at a roundtable in New York on Monday, “We still expect rate cuts in June and September, though there is a risk of delay.”

This forecast differs significantly from market expectations. The CME FedWatch Tool currently shows that the market generally expects the Fed to cut rates only once this year, by 25 basis points in December, due to the possibility that rising oil prices after the US-Iran war could reignite inflation and hinder the Fed’s ability to ease monetary policy.

Just last month, the market expected at least a 50 basis point cut this year, with a 60% probability of a 25 basis point cut in September. Economists at TD Securities and Barclays last week both pushed back their predictions for the next Fed rate cut from June to September.

Gapen further added that the Fed might delay its first rate cut until September or even December, and both scenarios could push the next cut into 2027.

“Our main risk is that the longer the Fed waits, the more likely it is to need to cut rates further,” he said.

Oil Shock

Brent crude has closed above $100 per barrel for three consecutive trading days, marking the longest streak since August 2022. With the US-Iran conflict stalemated, oil prices are likely to rise further.

Morgan Stanley stated that if international oil prices remain high at $125 to $150 per barrel for an extended period, it will suppress consumer spending and require support from the Fed. According to Gapen’s data, the likelihood of a US recession has increased from 10% before the military conflict to about 20%.

He said, “The economy can withstand prices around $90 to $100 per barrel. But if oil prices stay around $125 to $150 for a long time, it could very well trigger a recession.”

Key Indicators

Morgan Stanley’s Global Chief Economist Seth Carpenter said that the inflation spike caused by rising oil prices might be temporary.

“If the situation worsens to the point that it starts affecting economic growth, over time it could actually lower the underlying inflation trend, especially core inflation,” he said.

Meanwhile, in assessing the actual impact of oil shocks on the economy, Morgan Stanley’s Global Macro Strategist Matthew Hornbach highlighted a key market indicator — inflation swap rates.

Since oil prices first broke above $100 per barrel in 2022, the 1-year forward 1-year inflation swap rate has risen about 20 basis points, approaching 2.5%. Hornbach said that if this rate declines, it would signal buying Treasury bonds and pricing in more rate cuts — indicating that market focus is shifting from inflation concerns to demand destruction.

“This is the most important indicator on your dashboard,” he added.