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Morgan Stanley has revised its forecast and no longer anticipates any rate cuts by the Federal Reserve this year, altering its previous expectation of one reduction. The Fed’s response to market conditions will play a pivotal role in upcoming financial trends.
Research indicates that US inflation could rise to 5%, raising concerns for Jerome Powell. The market is currently pricing in a strong likelihood of a rate cut in June, with an expectation of 104 basis points in easing over the next year.
This outlook assumes the Fed will overlook tariffs, though some officials do not share this view. Powell is set to address the market at 11:25 am ET on Friday.
Shifting Market Expectations
The article lays out a revision in Morgan Stanley’s stance: they’re no longer expecting the US central bank to lower interest rates this year, which marks a sharp shift from their earlier view that there would be at least one reduction. The core argument is that the Federal Reserve’s position on interest rates is now more constrained, possibly due to recent economic data pointing towards persistent inflation. We’ve seen signs that inflation might climb back to 5%, which is well above the bank’s 2% target. That would certainly be a worrying development for Powell, who’s already under pressure to guide monetary policy without undermining financial stability.
The pricing in of over 100 basis points of easing by markets over the next 12 months shows a disconnect—what traders expect and what policymakers may actually deliver are increasingly out of sync. At the heart of this misalignment is a question of whether the Fed is willing to delay cuts even as the economy starts absorbing higher borrowing costs.
From our view, any assumptions that Powell and colleagues will entirely dismiss the effects of tariffs might be premature. While not all officials seem aligned in their take on escalating trade costs, it’s likely they’re factoring in more than just headline inflation figures. Strong labour data, sticky service-sector prices, and continued consumer spending make the case for cautious policy—especially if expectations for inflation keep moving upwards.
Potential Market Repricing Ahead
With Powell due to speak early Friday afternoon, it’s worth preparing for the possibility that his tone may edge decidedly hawkish. If he signals a more restrictive approach, we could see longer-dated yields jump and rate-sensitive assets adjust rapidly. Therefore, ahead of his remarks, it would be sensible to reassess exposure to positions that could suffer from re-pricing of rate expectations.
Short volatility trades might become vulnerable in this case, particularly on the front end of the curve where sensitivity to rate outlooks is sharpest. Recent skew in options positioning highlights a market leaning towards cuts, so any sharp statement could force an unwind. We’ve seen this movie before—policy signals shift, implied volatility spikes, and dealers scramble for delta.
It’s not just about whether a cut happens in June. What matters more now is communication. If Powell suggests that cuts are postponed until late in the year or even pushed into 2025, timing assumptions change, and with them come broader positioning shifts.
This means we should track the pace of incoming data—especially next month’s CPI print and employment figures. A miss either way can cause amplified moves given the sensitivity around Fed policy. The idea that markets can simply look through tariff-related inflation might have to be revised quickly if trade tensions worsen or global supply chains experience renewed pressure.
As for implied rates, we’re watching the SOFR futures strip for signs of repricing. The 2025 contracts in particular offer a valuable window into sentiment. If Powell leans more restrictive, we anticipate the long end steepening, even if short-term yields hold tight in the near term. That would suggest traders begin abandoning hopes of near-immediate easing and adjust for a longer restrictive cycle.
In this setup, strike selection becomes more important than ever in risk hedging. Risk reversals now offer attractive asymmetry if the Fed’s next move surprises on the restrictive side. In that case, delta hedging models could be strained, particularly if liquidity thins ahead of Friday’s remarks.
We should also take a close look at funding spreads, which have remained tight but could react sharply if rate expectations shift. If Powell manages to communicate firmness without sparking panic, we might just see mild flattening. But even a hint of a data-dependent delay could cause positioning to turn quickly, especially in short-term interest rate markets.
It’s becoming clear that any strategy built around the assumption of dovish policy risks being tested soon.
