Morgan Stanley points out that the upcoming January FOMC meeting is almost certain to keep interest rates unchanged, but the key lies in the tone. According to the report, Morgan Stanley, in its latest report released on January 23, expects the Federal Reserve to soothe the markets with a "dovish pause," meaning that while pausing rate cuts due to recent labor market stabilization, it will retain a bias towards future easing. For investors, the key to this meeting lies in the forward guidance. Based on Morgan Stanley's forecast, the Fed will maintain the target range for the federal funds rate at 3.50%-3.75% at the January meeting. This is not a return to a tightening cycle, but rather a tactical adjustment based on recent data. Subtle changes in the statement's wording: Morgan Stanley expects the FOMC statement to upgrade its assessment of economic growth from "moderate" to "solid." More importantly, it is anticipated that the Fed will remove the phrase regarding "increased downside risks to employment"—since they are choosing to pause, it logically implies their concerns about the labor market have eased. Retaining an easing bias: The key lies in the forward guidance. Morgan Stanley expects the statement to retain the phrase "in determining the extent and timing of any further adjustments to the target range" (Voting situation: Dissenting votes are expected. Morgan Stanley predicts Governor Miran will dissent, advocating for a 50-basis-point cut. Morgan Stanley expects the Fed to execute a "dovish pause," with the key being the statement's retention of wording like "considering additional adjustments" rather than "any adjustments," to暗示 an easing bias remains. Powell Press Conference Preview: Acknowledging Growth, But Not Abandoning the Inflation Target Powell's task at the press conference will be to explain the pause. Morgan Stanley believes Powell will rely on recent strong growth data, stabilized hiring, and a decline in the unemployment rate (to 4.375%) to justify the "pause." Qualitative Analysis: The core question for the market is: Is this a "dovish pause" intended to be followed by more cuts later, or the end of a cycle? Morgan Stanley believes Powell will signal the former. Although activity data has been stronger than expected, inflation data has not shown significant pass-through effects from tariffs, and the Fed remains confident that inflation will subside later this year. The Productivity Puzzle: Powell is expected to express optimism about productivity prospects (whether from automation or AI), providing theoretical support for a "high growth, low inflation" soft-landing scenario. Market Strategy: Ample Liquidity, Long Swap Spreads Despite the Fed pausing rate cuts, conditions in short-term funding markets remain accommodative. Morgan Stanley notes that repo rates have normalized quickly to below the IORB (Interest on Reserve Balances), indicating "more than ample" cash in the system. Reserve Management Purchases (RMP): The Fed is maintaining reserve levels through monthly purchases of $40 billion in Treasury bills. Morgan Stanley expects the holdings of bills in the SOMA account to exceed $600 billion by the end of 2026. This mechanism effectively absorbs market supply and maintains smooth functioning in funding markets. Trade Recommendation: Based on expectations for loose funding conditions and a steepening front-end of the curve, Morgan Stanley's rates strategy team maintains its recommendation to go long the 2-year UST SOFR swap spread, with a target of -14 bp. FX Outlook: Dollar Decline Halted, But Still Bearish Morgan Stanley's view on the foreign exchange market has undergone a revision. Previously, they believed the US economy would weaken in early 2026, dragging down the dollar, but current economic data shows strong US growth (2026 GDP growth forecast raised to 2.4%), and Fed rate cuts are delayed (pushed back from January to June and September). Nevertheless, Morgan Stanley maintains a moderately bearish view on the dollar for the following reasons: Synchronized Global Growth: Data from the Eurozone, Canada, and Australia is also strong, limiting one-sided support for the dollar from interest rate differentials. Yen Valuation: The yen remains undervalued by about 10% relative to Fed pricing. Morgan Stanley believes the Bank of Japan is not behind the curve, concerns about Japanese fiscal risks are exaggerated, and expects the yen's negative premium to收敛. Renminbi Factor: USD/CNY is expected to reach 6.85 by the end of Q1 2026, which also constitutes a downside pressure for the dollar. Asset Class Focus: Valuation Dilemma in MBS and Munis Agency MBS (Mortgage-Backed Securities): Following the announcement of a $200 billion purchase plan by GSEs (Government-Sponsored Enterprises), MBS spreads have narrowed significantly, even breaking through the average levels seen during past Fed reinvestment periods. Morgan Stanley strategists have therefore shifted to a neutral stance. Although a Fed delay in cutting rates is typically negative for MBS, the net demand from the massive purchase plan is sufficient to offset this negative impact. Municipal Bonds: Fundamentals are solid, but valuations are expensive. The yield ratio of 1-5 year municipal bonds to corporate bonds is at very low levels. Morgan Stanley warns that if the Fed delivers only an "ambiguous pause" rather than a clear dovish signal, the compression of spreads in front-end municipal bonds will be difficult to sustain and could even lead SMA (Separately Managed Account) buyers to shift to corporate bonds or Treasuries.
Comments