Morgan Stanley expects the Federal Reserve to leave its policy rate unchanged at the forthcoming meeting, while preserving what the bank describes as an easing bias in the face of oil-induced inflationary pressures.
In a research note, Chief U.S. Economist Michael Gapen said the firm continues to see the median Federal Reserve official projecting one interest-rate reduction this year and another in the following year, with the terminal federal funds rate remaining in the 3.0% to 3.25% range.
Gapen acknowledged that the recent oil price shock should push up headline inflation forecasts. He added, however, that both modelling and recent public comments from Fed officials indicate the central bank is likely to "look through" energy-driven price movements rather than react to them with tighter policy.
Morgan Stanley expects the Federal Open Market Committee to vote to hold rates steady, but forecasts that the meeting will see three dissents favoring an immediate rate cut, up from two dissents in January. The note cites signals from Governors Bowman, Waller and Miran, each of whom the bank says has indicated support for rate reductions.
"We have high conviction that the Fed will not respond with rate hikes," Gapen wrote. He further argued that the appropriate policy response is for the Fed to "look through" energy price pressures, remain on hold, or move to cut rates if economic activity weakens.
According to Morgan Stanley, the Fed’s updated projections should display higher headline inflation and a softer growth outlook, while leaving the dot plot unchanged.
On market positioning, the bank recommends a neutral approach to U.S. Treasury duration. It also advises maintaining long positions in 2-year SOFR swap spreads and staying received in June FOMC OIS contracts.
In currency markets, Morgan Stanley sees downside risk for the U.S. dollar if Chair Jerome Powell stresses that the Federal Reserve is discounting energy-driven inflation. The note cautions that "oil market developments" are likely to remain a central influence on foreign exchange trading.
Contextual note: The research outlook and market recommendations outlined above are those presented by Morgan Stanley in its analyst note and reflect the firm’s expectations as described by Michael Gapen.