Morgan Stanley economists recently provided their perspective on the latest economic data and its implications for potential Federal Reserve interest rate cuts. According to a note to clients on Friday, the investment bank highlighted a shift in market expectations towards favoring two rate cuts this year, identifying the July Federal Open Market Committee (FOMC) meeting as a plausible juncture for action.

Key insights from Morgan Stanley include:

1. Market Misalignment on Rate Cuts: While current market pricing anticipates two rate cuts in 2024, Morgan Stanley suggests the market is still underestimating the number of rate adjustments that may occur this year. Despite this, the firm emphasizes that more substantial evidence is needed before the Fed begins cutting rates.

2. Economic Data Trends: Recent economic reports, such as April's jobs numbers and retail sales data, have indicated a transition from previously observed upside surprises to downside surprises. This shift has influenced the market's expectations regarding the Fed's rate policy.

3. Inflation Trends: April's Consumer Price Index (CPI) data met market expectations, providing some relief. Morgan Stanley had forecasted this trend change, anticipating a resumption of disinflation while projecting that the Fed would maintain current rates until September due to data volatility.

4. Core PCE Inflation: Core Personal Consumption Expenditures (PCE) inflation, which had surged to an annualized rate of 4.4% in March from 1.6% in December 2023, is expected to decelerate. April's core PCE inflation tracked at 0.26% month-over-month, down from 0.32% in March. Morgan Stanley projects the three-month annualized pace of core PCE inflation to decrease to 2.7% by June.

In summary, while market expectations for rate cuts have increased, Morgan Stanley underscores the need for more compelling data to justify such moves by the Federal Reserve. The evolving trends in employment, retail sales, and inflation data will be crucial in shaping the Fed's decisions in the coming months.

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