Morgan Stanley: Predicts that it is "too early" for the Fed to cut interest rates in March.

According to recent data, Morgan Stanley believes that the road for the Federal Reserve to resist inflation is still difficult and long.

On Monday, Vishwanath Tirupattur, the quantitative research head at Morgan Stanley, wrote that the Fed is more likely to start cutting interest rates in June, rather than the market's previous expectation of March.

The aftermath of the bond market rebound at the end of last year continues to this day, implying strong market expectations for interest rate cuts. Morgan Stanley believes that it is still too early to conclude that interest rate cuts will begin in March. The recently released employment and inflation data, as well as speeches by senior Fed officials, all suggest this path.

However, there are also institutions that hold the opposite view. Barclays, in its latest research report, has brought forward its interest rate cut expectations from June to March and believes that the Fed can "safely cut interest rates", with a forecast of a 100 basis point cut this year.

Morgan Stanley: Key data suggests "no rate hike in March"

Morgan Stanley pointed out that the December non-farm payroll data and inflation data both support the view that "there will be no interest rate cut in March".

The number of non-farm payrolls in December increased by 216,000, exceeding expectations; the unemployment rate of 3.7% was lower than expected, with a 0.3 percentage point decrease in labor force participation rate.

The overall December CPI was higher than market expectations, and the year-on-year growth rate of core CPI fell but exceeded expectations, with a month-on-month growth rate of 0.3%.

The year-on-year growth rate of December PPI was 1%, lower than expected, and the month-on-month growth rate of core PPI remained unchanged, achieving the slowest growth rate since the end of 2020.

Morgan Stanley conducted a detailed analysis of these data:

Considering the simultaneous decline in household employment and labor force participation rate, and the fact that household employment data is inherently volatile, overall, the labor market remains tight and has not cooled down, which is a key factor for the Fed to decide whether to start cutting interest rates.

After unexpectedly rebounding in November, rental inflation only fell by 3 basis points in December and still remains sticky.

The deflation of core commodities has slowed down, with prices of clothing and automobiles rebounding; automobile insurance inflation remains high, and this trend is expected to continue until the first half of 2024.

Although overall PPI has cooled down, the PPI excluding food, energy, and trade services still grew by 0.2% on a month-on-month basis.According to comprehensive data analysis, Morgan Stanley predicts that the core PCE index, which the Federal Reserve favors more, will increase by 0.17% MoM in December, surpassing the 0.06% increase in November. It is expected that the inflation in core services consumption expenditure will accelerate, and core services inflation can better reflect the impact of monetary policy on prices.

In summary, Morgan Stanley believes that inflation will decline, but it may not decline in the long term, and the path to inflation resistance will be bumpy.

Frequent "Cold Water" from Federal Reserve Officials

Tirupattur pointed out that senior officials of the Federal Reserve have repeatedly sent hawkish signals to suppress expectations of a rate cut in March.

Previously, after the release of CPI data, Loretta Mester, a 2024 FOMC voter and President of the Federal Reserve Bank of Cleveland, "hawkishly stated":

"I think it's too early to bet on a rate cut in March. We need to see more evidence."

"The December CPI report just indicates that we need to do more, and these efforts need to be made in a restrictive monetary policy environment."

Austan Goolsbee, President of the Federal Reserve Bank of Chicago, also believes that it is too early to make a decision on a rate cut in March. He said:

"We don't like to be constrained before the release of phase data - making decisions about March, June, or January."

Thomas Barkin, a 2024 FOMC voter and President of the Federal Reserve Bank of Richmond, also stated that more evidence is needed to prove that inflation is moving towards the Fed's target. He believes that the Consumer Price Index report is "roughly as expected."

Tirupattur concluded at the end of the article that there is no convincing reason from either recent data or Fed speeches to support the view that there will be a rate cut in March, as Seth Carpenter, Chief Economist at Morgan Stanley, pointed out:

"Either the financial markets are under severe pressure, or inflation, employment, or both are significantly lower than expected, for a rate cut in March to happen."

Barclays Sings a Different Tune: Rate Cut in March, 100 Basis Points Cut by Year-End

However, Barclays holds the opposite view and has revised its rate cut expectations from June to March in a recent report.

Barclays believes that with inflation continuing to slow down, the Fed is expected to start cutting rates in March, reducing rates by 25 basis points at every other meeting, for a total of 100 basis points, bringing the rate to 4.25-4.50% by the end of 2024 and 3.25-3.5% by the end of 2025.Considering the performance of PPI and CPI data, as well as the recent PCE data gradually approaching the Federal Reserve's target, Barclays expects that the core PCE in the second half of 2023 will reach 1.9%, which will lower the PCE inflation expectation for the end of 2024 from 2.6% to 2.4%. It is expected that the Federal Reserve will lower the nominal policy interest rate (including inflation rate).

However, Barclays predicts that as PCE inflation gradually falls to the target, CPI and other PCE sub-index values may still show stickiness, so the Federal Reserve will not quickly ease its policy. The interest rate cut this year is not expected to exceed 150 basis points.

Finally, Barclays stated in the report:

"We believe that the FOMC can confidently start cutting interest rates without seeing a significant weakness in the economy or labor market.""The current unemployment rate is only 0.2% higher than the Federal Reserve's long-term forecast, so the FOMC will mainly make interest rate decisions based on inflation prospects."

However, Barclays' interest rate cut expectations are not as aggressive as the market. As of the time of writing, the CME FedWatch tool shows a 70% probability of the FOMC starting to cut interest rates in March, with a 25 basis point cut at each subsequent meeting, totaling 175 basis points, and reaching 3.5-3.75% by the end of the year.