Oil prices surge reigniting inflation concerns, Wall Street's interest rate cut expectations accelerate retreat, but Morgan Stanley chooses to go against the tide.
On March 16, according to Bloomberg, as several institutions pushed back their expectations for the Federal Reserve's first interest rate cut to September or even later, Morgan Stanley maintained that the Fed would restart rate cuts in June this year and complete a second cut in September. This stance is clearly at odds with current market pricing and peer judgments, making it a distinct &#34;minority&#34; position on Wall Street.
Michael Gapen, Chief U.S. Economist at Morgan Stanley, stated during a roundtable discussion on Monday, &#34;We still maintain our forecast for rate cuts in June and September, though the risk is that the timing may be delayed.&#34;
Following the outbreak of war in Iran, oil prices surged sharply, and market concerns about a resurgence of inflation quickly intensified, traders significantly reduced their bets on the extent of the Fed's rate cuts this year. Meanwhile, the Treasury market experienced massive sell-offs last week, with the yield on the 2-year U.S. Treasury bond, sensitive to monetary policy, briefly rising to nearly 3.75%, surpassing the Fed's excess reserve rate—an extremely rare occurrence.
The report noted that Michael Gapen also acknowledged that if the Fed chooses to wait until September or even December to initiate the first rate cut, the next window for a rate cut could be pushed back to 2027.
<h2>The Logic Supporting Morgan Stanley's June Forecast</h2>
The report stated that the core logic behind Morgan Stanley's June rate cut forecast lies in its assessment of the nature of the oil price shock—believing it to be a controllable, phase-based external shock rather than a persistent pressure capable of fundamentally altering inflation trends.
Seth Carpenter, Global Chief Economist at Morgan Stanley, pointed out that the inflation surge driven by oil prices is likely to be temporary. &#34;If the oil price shock is severe enough to start dragging down economic growth, over time, this will actually lower the underlying inflation trend, especially core inflation,&#34; he said.
In terms of economic growth, Michael Gapen believes that the current level of oil prices is still within the economy's tolerable range.
<blockquote>
&#34;The economy can absorb oil prices of $90 to $100 per barrel. It would likely require oil prices to remain in the $125 to $150 range for a prolonged period to create a reasonable probability of recession.&#34;
</blockquote>
He also noted that the probability of the U.S. economy entering a recession has risen from about 10% before the outbreak of military conflict to around 20%.
Morgan Stanley also emphasized that if oil prices remain high at $125 to $150 per barrel for an extended period, it would significantly dampen consumer spending, at which point the Fed would need to step in to provide support.
It is noteworthy that Morgan Stanley's expectations stand in stark contrast to market pricing and the expectations of other Wall Street institutions, which have significantly shifted due to the oil price shock affecting expectations for the Fed's rate cut path.
Futures contracts linked to the Fed's policy rate are currently pricing in only one 25 basis point cut in December, whereas just last month, the market expected at least a 50 basis point cut this year. The probability of a 25 basis point cut in September is currently about 60%.
The sharp fluctuations in the government bond market further confirm the shift in market sentiment. Last week, the yield on the 2-year U.S. Treasury rose to nearly 3.75%, exceeding the Federal Reserve's excess reserve rate, breaking through this rarely breached key level.
The market proxy indicator for the terminal rate, which measures the endpoint rate of the Federal Reserve's current easing cycle, has risen by about 50 basis points since the end of February, reaching over 3.4%.
In this regard, Michael Gapen stated, &#34;The increase in the 2-year yield surprised me a bit. I can understand the rise in long-term rates, but the terminal rate being repriced to such a high level is indeed unexpected.&#34;
At the same time, there has also been a collective shift at the institutional level. TD Securities and Barclays Bank have both pushed back their forecasts for the Federal Reserve's next rate cut from June to September.
<h2>A Key Indicator: Inflation Swap Rate</h2>
When assessing the actual impact of oil price shocks on the economy, Matthew Hornbach, Global Macro Strategy Chief at Morgan Stanley, highlighted a market indicator worth paying attention to—the inflation swap rate.
Since crude oil prices first broke $100 per barrel since 2022, the 1-year forward 1-year inflation swap rate has risen by about 20 basis points, approaching 2.5%.
Hornbach stated that if this rate falls back, it would signal a buying opportunity for government bonds and pricing in more rate cuts—indicating that the market's focus is shifting from inflation concerns to demand destruction. Hornbach said:
<blockquote>
&#34;This is the most important indicator on your dashboard.&#34;
</blockquote>
This framework suggests that Morgan Stanley is not ignoring oil price risks but is using the trend of the inflation swap rate as the core basis for dynamic adjustment judgments—once there are clear signs of deterioration on the demand side, its rate cut forecast path will also be revised accordingly.
Although Morgan Stanley maintains its baseline forecast, Michael Gapen also clearly pointed out the downside risks: If the Federal Reserve delays its first rate cut until September or even December, the next rate cut window may be pushed back to 2027.
<blockquote>
&#34;The risk we face in our view is that the longer the Federal Reserve waits, the more likely it may need to add an additional rate cut.&#34;
</blockquote>

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Compared to the only rate cut of 25 basis points this year in line with market pricing, Morgan Stanley insists on rate cuts in June and September against the trend. Its core logic is that the oil price shock is a temporary external disturbance, leading to non-persistent inflationary pressures; oil prices in the range of 90-100 USD are still within the economy's tolerance. Meanwhile, the bank uses inflation swap rates as a key indicator for dynamic adjustments and warns that if the rate cut is delayed until September or December, the next window may be pushed to 2027

- Oil prices surge, raising inflation concerns and leading to reduced rate cut expectations on Wall Street, yet Morgan Stanley maintains its forecast.  
- The firm predicts the Federal Reserve will cut rates in June and September, contrasting with broader market views, which have pushed back rate cut timelines.  
- Morgan Stanley’s stance is based on a belief that current oil price impacts are manageable and temporary, although the risk of economic downturn has increased to about 20%.

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Insisting on the "June interest rate cut" prediction, Morgan Stanley stands out in Wall Street's "delayed interest rate cut wave."