Three Hikes? You‘re Out: US Rates Strategy | North America

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Three Hikes? You‘re Out: US Rates Strategy | North America

IdeaMThe market-implied path for Fed policy prices in just under 50bp of rate hikes by March

2027—in essence, putting about a 50% probability on the 100bp of rate hikes our

economists would envision in a scenario where real GDP grows nearly 3% in 2026 and

2027 and a firming in core PCE inflation through early 2027—quite far from their baseline

view (see Exhibit 3 and Exhibit 4 ).

Exhibit 3: Subjective probabilities that produce a Exhibit 4: Target fed funds range upper bound and

market path most closely aligns to the current market-price-aligned probability-weighted mean vs.

market-implied path market pricing

%

6 Permanent oil premium 0

Global oil-led recession 0

4.06

4 4.05

US AI productivity boost 22 3

US aggregate demand shock 57

Baseline 22

'16 '17 '18 '19 '20 '21 '22 '23 '24 '25 '26 '27

0 10 20 30 40 50 60 % Market-equivalent probability-weighted mean

Market-implied subjective probability assigned Market pricing (upperbound)

Source: Morgan Stanley Research estimates, Federal Reserve, Bloomberg Source: Morgan Stanley Research estimates, Federal Reserve, Bloomberg

Of course, relative to the consensus economist view coming into this year, data—both

relating to growth and inflation—surprised to the upside so far and, in doing so, bucked

the seasonal patterns of the past few years (see Exhibit 5 and Exhibit 6 ).

As a normal consequence of human psychology, the better-than-expected growth data

and higher-than-expected inflation data caused investors and economists alike to either (1)

reassess risks around their expectations for real growth and inflation or (2) gain

confidence in their previous above-consensus views.

Exhibit 5: Bloomberg US economic surprise index Exhibit 6: Bloomberg US economic surprise index