Why the Fed May Have Further to Go

Summary

Andrew Sheets of Morgan Stanley explains why the Fed may have further to go after its latest rate hike. He notes the Fed still does not see policy as restrictive and outlines resilient economic activity, too-high inflation, and geopolitical/energy risks as key drivers. Morgan Stanley economists expect two additional quarter-point hikes in December and March, with rates then held through 2027. Energy markets and oil prices remain a major wild card for the inflation and policy outlook.

• The Fed raised interest rates by a quarter point, but Chair Powell described it as removing a dose of accommodation and said policy is not clearly restrictive.
• Andrew Sheets says this language shifts the market debate and suggests the Fed may have further to go.
• Morgan Stanley economists expect two more quarter-point hikes in December and March, followed by a hold through 2027.
• Resilient earnings, loan growth, and corporate activity suggest the current rate level is not holding back the broader economy.
• Inflation remains too high, with too many categories above 3%, and the Fed is not convinced it is returning sustainably to 2%.
• Geopolitical developments and high oil prices are key risks, especially through second-round inflation effects such as airline tickets.
• The Fed raised its longer-run neutral rate estimate to about 3.25%, which makes current policy less restrictive.
• The outlook could change if energy prices fall, geopolitical tensions ease, or inflation improves faster.