A Federal Reserve official has made a statement, with Morgan Stanley issuing its latest prediction.
Federal Reserve Governor Christopher Waller stated at a meeting in Rome that the central bank would not deliberately keep interest rates low to assist the U.S. government in financing its fiscal deficit. Waller believes the Fed Chair is reaffirming the commitment to achieving the 2% growth target; he prefers setting the inflation target as a range, but changing the target framework at this moment would lack credibility.
Notably, Waller also indicated that, if used appropriately, policymakers' signaling of future interest rate paths can still play a positive role. This statement contrasts sharply with the Fed Chair's deliberate downplaying of forward guidance.
Previously, the Fed Chair committed to reducing the central bank's reliance on so-called "forward guidance," shifting towards a more data-dependent approach for adjusting policy.
Waller expressed that forward guidance remains a valuable policy tool. During the period of surging inflation amid the pandemic, forward guidance helped the central bank signal to the public that rates would be increased. Even before the Fed officially raised rates, financial conditions tightened in anticipation. However, he also noted that Fed officials sometimes applied forward guidance too rigidly, which ended up constraining their own policy flexibility. He cited examples from 2020 and 2021 when the Fed explicitly stated it would keep rates unchanged for a period, even as inflation was beginning to rise rapidly.
Currently, regarding whether the Fed will raise rates this year, Morgan Stanley's latest forecast indicates no rate hikes this year.
The latest prediction from Morgan Stanley's Chief Global Economist, Seth B. Carpenter, shows that while economic data could change the policy path at any time, last week's non-farm payroll data, which came in significantly below expectations, still gives the Fed room to wait and see. Carpenter pointed out, "Combined with our inflation forecast being well below the FOMC's median projection, and the potential for PCE inflation measurement adjustments to substantially lower inflation readings, we maintain our original judgment: the Fed will not raise rates in 2026."
Based on the prediction of weakened expectations for Fed rate hikes, Morgan Stanley's interest rate strategists recommend that investors bet on shorter-duration U.S. Treasury yields falling relative to longer-duration yields. The result would be a steepening of the U.S. Treasury yield curve, meaning the spread between shorter and longer maturities widens. Specifically, on July 2nd, Morgan Stanley recommended betting on a widening spread between 7-year and 30-year U.S. Treasury yields. This spread was near 65 basis points during Monday's U.S. trading session, compared to 63 basis points when the recommendation was made. The firm set a target spread of 100 basis points. Despite weak June employment data released on July 2nd prompting the U.S. interest rate market to scale back pricing for Fed tightening, strategists including Matthew Hornbach wrote that market pricing remains too high. "Weaker employment data combined with current market pricing creates an opportunity for investors to reposition for a steepening U.S. Treasury curve trade."
However, there are also voices suggesting that, although the Fed kept rates unchanged last month, officials are signaling increasing support for a rate hike this year as U.S. inflation has climbed to its highest level since 2023.
The latest released interest rate projections show that among 18 Fed officials, half anticipate at least one more rate hike this year.
According to the latest forecast from CME's "FedWatch Tool": the probability of the Fed maintaining the current rate in July is 74.3%, with a 25.7% probability of a cumulative 25-basis-point hike. The probability of the Fed maintaining the rate by September is 42.9%, with a 46.2% probability of a cumulative 25-basis-point hike and a 10.8% probability of a cumulative 50-basis-point hike.
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