Morgan Stanley’s View on Rate Cuts

Recently, there have been seemingly daily contradictions in reports about what is happening between the US, Israel and Iran. The latest example is Trump’s claim that Iran requested a pause in strikes. According to The Wall Street Journal, Iran says it made no such request. As the old saying goes, the first casualty of war is the truth, and that appears to be playing out now. It is in Iran’s interest not to appear weak or as though it is backing down, while the US has its own incentive to downplay the conflict and limit the spike in oil prices.

The Fed and other central banks now find themselves in an unforgiving position. If they cut rates, that could add further upward pressure to oil prices, raising production costs across a wide range of essential goods and services. If they hike to contain inflation, they increase the burden on mortgages and other interest-sensitive debt, which would also be punishing. To bring this kind of inflation under control, oil supply — and confidence in that supply — needs to recover. That will be extremely difficult without de-escalation in Iran.

Morgan Stanley has now pushed back its rate cut forecast to September and December. Its reasoning is centred on the oil situation outlined above, along with the impact of tariffs. It had previously been looking for cuts in June and September, but the oil shock has delayed that view.

Some important questions remain. If the war ends sooner than expected, the door could quickly reopen for earlier cuts. But if the conflict drags on, how long can the US economy sustain it while rates remain high? The situation is beginning to look like a policy bind, and the recent pullback in gold may prove temporary once the market fully absorbs how few good options are available.