Morgan Stanley: Did the Federal Reserve make a mistake by cutting interest rates by 50 basis points in September?

Morgan Stanley's Chief Global Economist Seth Carpenter wrote that investors have been paying close attention to whether the Federal Reserve's significant rate cut in September was a policy mistake, and his view is that the Fed did not make a mistake. Here are his points.

The discussion about the Fed keeps coming back to whether the 50 basis point rate cut in September was a policy error. My personal view is "no", we won't see inflation pick up because of this decision, but I do believe that if the Federal Open Market Committee knew how strong the September employment report would be, especially with revisions to previous months, the Fed would have only cut rates by 25 basis points.

In this context, I have heard almost no one argue against our basic call for consecutive 25 basis point rate cuts. In short, we are achieving a soft landing. The front end of the curve is pricing in call options for our Fed, the 10-year Treasury is in the middle of the range, consistent with our rate strategy team's view, and risk assets seem to be receiving the mild support we expected.

As expected, every conversation I have in London turns to the U.S. election. I framed the discussion around three policy levers that could impact the macroeconomy.

Meaningful fiscal policy reform by the next U.S. president requires control of both houses of Congress, and current polling cannot predict this outcome.

On the issue of immigration, I want to emphasize that immigration has brought a substantial, positive labor supply shock, supporting over 3% of GDP growth in the context of ongoing disinflation. Therefore, a sharp reversal in immigration numbers would bring stagflationary shocks, slowing economic growth while pushing up inflation. But the key second point is that immigration numbers may slow on their own. Therefore, the impact of changes in immigration policy is somewhat uncertain.

The biggest divide across the ocean is on the issue of tariffs. In the U.S., most clients doubt former President Trump's commitment to increasing the substantial tariffs he promised. Our view is that imposing all the tariffs currently under discussion could raise inflation by less than 1 percentage point, while dragging down economic growth by about 1.5 percentage points.

Regarding Europe, in some articles, I emphasized our recent call that the European Central Bank should accelerate its rate-cutting cycle and end with policy rates below neutral. I discussed in other meetings the recent discussions in France, Italy, and the UK about fiscal consolidation. Italy is of particular interest due to factors affecting its outlook. Our forecasts are below consensus, and we see downside risks that fiscal consolidation could exacerbate. Additionally, the link between Italy's manufacturing sector and the sluggish German economy has intensified this trend