Morgan Stanley joins global peers with September Fed rate cut outlook as Powell shifts tone

Morgan Stanley now forecasts a September 25-basis-point Federal Reserve rate cut, aligning with a growing consensus among major brokerages like Barclays and Deutsche Bank, following Chair Jerome Powell's recent shift in tone towards labor market risks at Jackson Hole. This marks a significant pivot for Morgan Stanley, which previously expected a hold until March 2026, now projecting two 25bp cuts this year (Sept, Dec) and quarterly reductions through 2026 to 2.75%-3.0%. The revised outlook reflects a perceived change in the Fed's reaction function, with traders pricing an 81.9% chance of a September move, while political efforts to influence the Fed, including potential changes to the Board of Governors, add further complexity to the FOMC's future composition.

Analysis

A significant dovish shift in market expectations has occurred, with Morgan Stanley now aligning with a growing consensus of major brokerages, including Barclays and Deutsche Bank, in forecasting a 25-basis-point Federal Reserve rate cut in September. This represents a material pivot for Morgan Stanley, which previously anticipated rates holding until March 2026 but now projects two cuts this year and quarterly reductions through 2026 to a terminal rate of 2.75%-3.0%. The catalyst for this widespread revision is a perceived change in the Fed's reaction function, following Chair Powell's remarks at Jackson Hole which signaled increased sensitivity to labor market risks. This sentiment is strongly reflected in market pricing, with traders assigning an 81.9% probability to a September cut. However, potential constraints remain; Morgan Stanley notes that larger cuts would require significant payroll declines and anticipates possible dissents within the FOMC. Compounding this economic uncertainty is a new political variable, as the Trump administration's effort to remove Governor Lisa Cook could alter the FOMC's composition, a risk highlighted by J.P. Morgan. BofA Global Research remains the notable outlier, maintaining a no-cut forecast for the year.

Key Decisions for Investors

• Given the strong consensus for a dovish pivot, consider increasing exposure to rate-sensitive assets such as long-duration bonds and growth-oriented equities, which typically benefit from a lower interest rate environment.
• Closely monitor upcoming labor market reports, as the Fed's new reaction function makes payroll and unemployment data the primary catalyst for the timing and magnitude of future rate adjustments.
• Factor in the heightened political risk surrounding Federal Reserve governance, as potential changes to the Board of Governors could introduce policy uncertainty and market volatility independent of economic data.
• Acknowledge the contrarian risk highlighted by BofA's forecast and the potential for FOMC dissents by maintaining portfolio flexibility ahead of the September meeting to hedge against a potential hawkish surprise.