Morgan Stanley Admits Mistake and Predicts December Fed Cut
- Morgan Stanley reversed its forecast and now expects a Federal Reserve rate cut in December due to overwhelming market pricing
- The bank's previous prediction of a January 2026 cut was based on misleading hawkish comments from Chair Jerome Powell in October
- Analysts expect the Fed to deliver the cut but enforce a stricter standard for any future reductions to manage internal dissent
 |
| Photo by Maxim Hopman on Unsplash |
Forecasting the Federal Reserve has become a dangerous game. Even the biggest banks on Wall Street are struggling to keep up with the mixed signals coming from Washington. Morgan Stanley just provided a perfect example of this volatility. The bank has officially flip flopped on its interest rate prediction for the second time in two months. The economics team led by Michael Gapen had previously been convinced to change their outlook. They listened closely to Fed Chair Jerome Powell in October. His rhetoric at the time was hawkish and stern. He signaled that another rate cut was not a guarantee. This caused Morgan Stanley to push their forecast for the next reduction all the way to January 2026.
That prediction turned out to be wrong. The facts on the ground have shifted rapidly since that October speech. The market has effectively bullied the central bank into a corner. Traders are now pricing in a 95 percent chance of a rate cut happening next week. The consensus is overwhelming. Morgan Stanley had no choice but to reverse course. The Federal Reserve historically hates to surprise the market. If the market expects a cut with near certainty then the Fed usually delivers it. Gapen recognized this dynamic. He invoked the famous economic philosophy that when facts change opinions must change too.
The bank is now calling for a 25 basis point cut in December. This aligns them with the broader market sentiment. It is a humble admission that the earlier signal from Powell was a "bum steer." The Fed Chair managed to convince smart analysts to zig just before the data forced him to zag. This decision does not come without complications. Gapen expects the meeting next week to be contentious. There will likely be dissent among the board members. Not everyone inside the Fed agrees that the economy needs more juice right now. The cut will happen but it might not be unanimous.
The compromise will likely come in the forward guidance. Powell may agree to cut rates now in exchange for a tougher stance later. Gapen predicts the Fed will establish a "higher bar" for any future reductions in 2026. They will give the market its holiday gift but warn that the party is over for a while. The long term outlook remains unchanged despite the short term shuffle. Morgan Stanley still sees the terminal rate landing between 3.00 percent and 3.25 percent. This is the final resting place for interest rates in this cycle. It is significantly lower than the current target range.
Currency traders are watching this flip flop closely. A rate cut in December is generally bad for the US dollar. Lower yields make the greenback less attractive to hold. Gapen expects the move to soften the dollar slightly. He specifically points to weakness against the Australian and Canadian dollars. The broader lesson here is about the reliability of Fed communication. Investors hang on every word Powell says. Yet those words are often rendered obsolete by new data within weeks. The October hawkishness feels like a distant memory. The dovish reality of December has taken over.
Wall Street analysts are often accused of herd mentality. In this case the herd was right and the outlier had to join them. Morgan Stanley tried to take a contrarian view based on specific guidance from the top. That guidance failed. They are now back in the fold. The upcoming meeting will set the tone for the new year. If Powell cuts rates but sounds angry about it the market might stumble. If he cuts and sounds dovish the rally could extend. Morgan Stanley is betting on a "hawkish cut." This is a move that eases policy while promising to be stingy in the future.
This constant recalibration shows how fragile the economic narrative is. We are in a period where a single data point or a single sentence can shift billions of dollars in expectations. The path to a soft landing is not a straight line. It is a series of zig zags and U turns. Investors should be prepared for volatility regardless of the decision. The 95 percent probability suggests the cut is priced in. The real action will happen when Powell opens his mouth at the press conference. He fooled Morgan Stanley once. The market will be trying to ensure he doesn't fool them again.