Global Market: Morgan Stanley turns hawkish, sees two Fed rate hikes in 2026

Morgan Stanley has joined a growing number of major Wall Street banks in taking a more hawkish view on global interest rates, forecasting additional monetary tightening by both the U.S. Federal Reserve and the European Central Bank as inflationary pressures remain persistent.

According to Reuters, Morgan Stanley expects the Fed to raise its benchmark interest rate by 25 basis points at its September 15-16 meeting and deliver another quarter-point increase in December. The forecast follows recent U.S. inflation data that came in stronger than expected.

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Inflation keeps Fed under pressure
Morgan Stanley's revised outlook reflects concerns that the decline in inflation has not been strong or consistent enough to give policymakers confidence that price pressures are returning sustainably toward the Fed's target.

The brokerage now expects two Fed rate hikes this year and sees the central bank signalling the possibility of further tightening before eventually pausing as inflationary pressures ease.

Morgan Stanley's assessment was influenced by several factors, including potential second-round effects from higher energy prices, strong demand associated with artificial intelligence-related investment and the possibility that the economy's neutral interest rate is temporarily higher.

The outlook also reflects concerns over the Fed's policy credibility at a time when inflation remains above target.

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Oil prices add to inflation risks
The outlook for U.S. monetary policy has become more complicated as oil prices remain above $100 a barrel, increasing concerns about renewed inflationary pressure.

Investors are also closely watching the Fed under Chair Kevin Warsh, who took over the central bank's leadership in May. Warsh has so far avoided providing clear guidance on the future path of interest rates.

Markets are heavily pricing in a rate increase at this week's meeting, which would mark the first hike of Warsh's tenure.

Morgan Stanley raises ECB rate forecast
Morgan Stanley has also changed its outlook for the ECB, reversing its earlier view that the European central bank's tightening cycle had ended.

The brokerage now expects the ECB to raise its deposit rate by another 25 basis points in December to 2.75%. Reuters reported that Morgan Stanley pointed to resilient eurozone economic growth and higher energy prices as key reasons behind the revised forecast.

The brokerage has also reduced its expectations for monetary easing in Europe. It now sees only one ECB rate cut in 2027, with that reduction expected in December.

Global markets brace for higher rates
The more hawkish forecasts from Morgan Stanley come at a crucial time for global financial markets, with investors preparing for policy decisions from the Fed and Bank of Japan this week.

The ECB's recent return to a tightening bias has added to uncertainty over the global interest-rate outlook. Higher oil prices, persistent inflation and resilient demand are increasing the risk that central banks may need to keep borrowing costs elevated for longer than previously expected.

The shift in expectations could have implications across bond, equity and currency markets as investors reassess the likelihood of prolonged monetary tightening.

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