Morgan Stanley maintains its view of no Fed rate hikes in 2026, but provides a roadmap of inflation, labor, and oil-price triggers for hikes

Overview

This report is Morgan Stanley's US economics weekly and evaluates whether the Fed will raise rates in 2026 based on the US data path after the June FOMC. The base-case judgment is that the Fed will keep the policy rate unchanged this year because inflation is expected to slow, job growth will cool, consumer spending has already weakened significantly, and the recent pullback in oil prices may make some FOMC inflation forecasts look too high. At the same time, the report clearly lays out the conditions that would trigger a reassessment: core inflation remaining above 0.3% m/m, renewed Middle East conflict pushing oil prices higher, employment outperforming expectations and driving the unemployment rate below 4.0%, or some members choosing tighter policy for risk-management reasons rather than relying fully on the data.

Core views

The core views include: first, Morgan Stanley believes FOMC participants may be overestimating inflation pressures, especially against the backdrop of falling oil prices after the US-Iran memorandum of understanding; the bank forecasts 2026 4Q/4Q headline PCE and core PCE at 3.2% and 3.0%, respectively, below the FOMC median participant. Second, the report expects monthly core PCE and core CPI readings to be at 0.2% or lower in the coming months, while a rise to 0.3% or higher would materially increase the risk of rate hikes. Third, on employment, the recent strong nonfarm payrolls may include catch-up hiring effects after policy shocks, and summer job growth is expected to slow to 50k-60k per month; if the unemployment rate falls below 4.0%, the Fed may shift to tighter policy to prevent overheating. Fourth, GDP and consumption data have weakened, with 2Q GDP tracking revised down to 2.5% annualized, reducing the need for immediate rate hikes.

Analysis framework

The report uses a macro data-roadmap approach, breaking the Fed policy path into observable indicators such as inflation, employment, oil prices, financial conditions, tariffs, and GDP tracking. The authors treat June-August data as the key window because these data will be incorporated into decision-making before the September FOMC meeting; they also cross-check using the FOMC dot plot, PCE/CPI forecasts, nonfarm payroll and unemployment-rate thresholds, the FRB/US financial conditions model, EIA petroleum inventory data, tariff cash-flow proxy indicators, and GDP nowcasts.

Methodology notes

• Monetary policy frameworkData roadmap to rate hikes

  Use inflation, employment, and oil-price thresholds to judge whether the Fed will shift from staying on hold to raising rates.

  The report views core inflation at 0.3% m/m or higher, the unemployment rate falling below 4.0%, and renewed Middle East conflict driving energy prices higher again as key trigger conditions that could change the base-case view.

• Financial conditions modelFRB/US Financial Conditions Index

  Convert asset-price changes into an equivalent change in the federal funds rate in terms of their impact on economic activity.

  The index includes the 10-year Treasury yield, S&P 500 returns, BBB credit spreads, dollar valuation, and oil prices, and aggregates them using growth elasticities in the FRB/US model; the report says financial conditions have tightened by about the equivalent of a 40bp increase in the federal funds rate since February 28.

• Growth tracking2Q GDP tracking model

  Use high-frequency economic data to update quarterly annualized GDP growth, along with contributions from consumption, investment, trade, and inventories.

  The report lowered 2Q GDP tracking from 3.0% a week earlier to 2.5%, mainly due to the 1Q GDP revision and April-May consumption and trade data.

• Trade policy monitoringEffective tariff rate and rebate proxy indicators

  Monitor the actual tariff burden through import composition, tariff substitution arrangements, and Treasury/CBP cash flows.

  The report estimates the effective tariff rate at about 6.9% in April and 8.3% on average in 1Q26, and uses CBP-related withdrawals in the Daily Treasury Statement as a proxy for tariff rebates.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• US front-end rates and federal funds rate expectations

  Directly affected by whether the Fed raises rates

  Strengths

  The base-case scenario is no hikes, reducing pressure for further hawkish repricing.

  Weaknesses

  If core inflation stays at 0.3% m/m or the unemployment rate falls below 4.0%, front-end rates could move higher again.

  Comparison

  Compared with some FOMC participants, Morgan Stanley is more benign on inflation and therefore more dovish on the policy path.

  Risks

  Upside inflation, overheating employment, hawkish risk management by members.

• 10-year US Treasury

  Affected through financial conditions and growth/inflation expectations

  Strengths

  Weaker consumption and GDP tracking help limit upside in long-end yields.

  Weaknesses

  Financial conditions have already tightened, and high oil prices or tariffs could raise the inflation risk premium.

  Comparison

  The 10-year Treasury yield is one of the five variables in the FRB/US Financial Conditions Index.

  Risks

  Oil-price rebound, rising inflation expectations, fiscal and tariff uncertainty.

• S&P 500 and US risk assets

  Affected jointly by financial conditions, rate expectations, and growth momentum

  Strengths

  A Fed hold and equity-market resilience can support valuations.

  Weaknesses

  Downward revisions to consumption and slower employment may weaken earnings expectations.

  Comparison

  The report says the equity-market rally offset part of the tightening in financial conditions.

  Risks

  Higher probability of rate hikes, weaker growth data, oil-price shocks.

• US dollar

  Dollar moves are an important driver of the Financial Conditions Index

  Strengths

  If the Fed does not hike, policy support for further dollar strength is limited.

  Weaknesses

  In the model, dollar depreciation is instead described in the report as one of the main contributors to recent tightening in financial conditions, indicating that the transmission direction depends on model setup and growth elasticities.

  Comparison

  Easier financial conditions earlier in the year were mainly driven by dollar weakness, while net tightening after February 28 was also primarily related to dollar moves.

  Risks

  Reversal in policy expectations, safe-haven demand, trade policy uncertainty.

• Crude oil and energy-related assets

  Oil prices are important variables for inflation and financial conditions

  Strengths

  Oil prices have retreated since mid-June, helping reduce inflation pressure.

  Weaknesses

  Spot oil prices are still above pre-Iran-conflict levels, and falling inventories indicate supply-demand conditions remain tight.

  Comparison

  Futures prices have fallen back, but physical market prices remain relatively high.

  Risks

  Renewed Middle East conflict, renewed disruption in the Strait of Hormuz, second-round energy inflation effects.

Key data

• Fed policy base-case viewNo rate hikes in 2026The stay-on-hold view was maintained after the June FOMC, and recent data have made this view marginally more solid.
• Core inflation thresholdCore PCE and core CPI are expected to be around 0.2% m/m or lower; 0.3% m/m or higher would change the viewUpside inflation surprises are the primary risk in the rate-hike roadmap.
• 4Q/4Q PCE forecastHeadline PCE 3.2%, core PCE 3.0%Morgan Stanley believes this forecast is meaningfully below the FOMC median participant.
• Energy price assumptionPCE energy prices down about 5.0% in June and about 2.6% in JulyIf Middle East conflict reignites, the assumption of falling energy prices may fail.
• Summer employment growth forecastAbout 50k to 60k per monthThe report expects recent nonfarm strength to be unsustainable, with the unemployment rate staying roughly near current levels.
• Unemployment-rate risk thresholdBelow 4.0%If the unemployment rate falls below 4.0% before September, the Fed may judge the labor market to be overheating.
• June nonfarm payroll forecastHeadline nonfarm 90k, private nonfarm 95k, unemployment rate 4.3%Average hourly earnings are expected at 0.2% m/m and 3.4% y/y.
• Change in financial conditionsTightened by about 40bp since February 28; tightened 22bp after the June FOMCMainly driven by changes in the dollar, the 10-year Treasury yield, and equity-market returns.
• Petroleum inventoriesUS petroleum inventories including SPR declined by about 2 million barrels per dayCrude and refined product inventories continue to fall, while higher exports reduce net imports.
• Effective tariff rateAbout 6.9% in April, 8.3% average in 1Q26The baseline tariff estimate is close to 11%, and core tariffs excluding fuel, gold, and AI-related imports are about 13% to 14%.
• 2Q GDP tracking2.5% q/q annualized, previous 3.0%2Q consumption tracking fell from 2.9% to 1.9%, while 1Q consumption was revised down from 1.4% to 0.5%.
• First-half consumption growthAbout 1.2% annualizedResidual seasonality and higher tariffs may weigh on consumption.

Impact & implications

For asset allocation, the report's base-case scenario suggests that upside rate risk is contained: if inflation continues to slow and employment cools, there is limited room for further hawkish repricing in front-end rates and the dollar, and risk assets could benefit from the Fed refraining from hiking. But the report also stresses that oil prices, core inflation, and employment have clear upside triggers; if data surprise to the upside, markets may reprice toward a higher policy-rate path, pressuring US equity valuations and pushing Treasury yields higher. Tariffs and weaker consumption also suggest that US growth resilience is not risk-free, and subsequent GDP and consumption revisions could affect cyclical assets and the dollar.

Risks

• Core PCE or core CPI monthly readings remain at 0.3% or higher for consecutive months, forcing the Fed to reconsider rate hikes.
• The US-Iran memorandum of understanding breaks down or Middle East conflict reignites, causing energy prices to rise and pushing up core inflation through second-round effects.
• Employment is stronger than expected and the unemployment rate falls below 4.0% before September, causing the Fed to worry about an overheating labor market.
• Some FOMC participants may push for tighter policy based on risk management rather than the data itself, reducing the constraining power of the data on decisions.
• 2Q services consumption estimates are based on fewer input data points, and later quarterly services surveys could lead to large revisions in GDP and consumption tracking.
• Tariff substitution arrangements, the Section 122 timeline, and subsequent Section 232/301 investigations increase trade policy uncertainty.

What to watch

• Whether monthly core CPI and core PCE from June to August remain around 0.2% or lower.
• The June employment report, subsequent nonfarm payroll growth, and whether the unemployment rate approaches or falls below 4.0%.
• Middle East developments, implementation of the US-Iran memorandum of understanding, risks around the Strait of Hormuz, and the oil-price curve.
• US crude and refined product inventories, SPR changes, domestic production, exports, and net imports.
• 2Q GDP tracking, May-June trade data, June retail sales, and revisions to services consumption.
• Effective tariff rates, tariff revenue, CBP rebate proxy indicators, and follow-up policy arrangements after Section 122.
• The 10-year Treasury yield, US dollar, S&P 500, BBB spread, and oil prices within the FRB/US Financial Conditions Index.
• FOMC member remarks, especially whether they continue to emphasize upside inflation risks ahead of the September meeting.