Federal Reserve "turns hawkish"? Morgan Stanley: I've seen this episode before!

The Fed is hawkish, emerging markets don't feel great, but Morgan Stanley is confident. On December 20th, Morgan Stanley's American economist Michael T. Gapen and his team published an article stating that the Fed's current hawkish outlook is largely consistent with their forecasts - Trump's trade and immigration policies may keep inflation strong and delay further interest rate cuts by the Fed. Morgan Stanley stated that the timing and magnitude of rate cuts will depend on the progress of Trump's restrictive policies, but the impact of these policies on economic activity may also lag, so although the Fed is currently hawkish, they may turn dovish in the future. Just like in 2018, when the Fed predicted further rate hikes, but eventually chose to cut rates as economic activity slowed down. Currently, the Fed has made it clear that if Trump's new policies lead to inflationary pressures, the Fed will slow down the pace of rolling back restrictive policies, and may even raise rates in some cases. However, Goldman Sachs believes that in the long run, we believe that the negative impact of these policies on economic growth may outweigh the short-term impact on inflation, prompting the Fed to cut rates to support the labor market. If this is true, Goldman Sachs believes that the Fed in December of this year may face a similar situation to the Fed in December 2018. In 2018, the Trump administration began imposing tariffs and gradually expanded the scope of tariffs on products and countries, import price pressures led to inflation reaching the long-awaited 2% target. At that time, the Fed was not overly concerned about the risks of rising inflation, but the committee still believed that further policy tightening was needed. In September 2018, the Fed projected three rate hikes in 2019 and one more in 2020, but by December 2018, this forecast was revised down to two rate hikes in 2019 and one in 2020. Eventually, as manufacturing output continued to decline, the Fed stood still and finally turned to rate cuts in July 2019. Goldman Sachs: Fed's expectations align with ours At the FOMC meeting on December 18, the Fed cut rates by 25 basis points as scheduled, but issued a hawkish forward-looking guidance, with the dot plot showing only two rate cuts expected by 2025, rather than the previous four. The Fed stated that the growth of economic activity in the United States will slightly slow down within expectations, the unemployment rate will remain at a low level, and inflation will be significantly stronger, therefore, the number of expected rate cuts next year will decrease. Analysts pointed out that the Fed's focus has shifted from downside risks in the labor market to concerns about a resurgence of inflation, especially since Trump took office, tariff hikes, immigration restrictions, and loose fiscal policies will bring significant upside risks to inflation. Goldman Sachs stated that these statements from the Fed do not mean that they have become more hawkish, after all, the Fed still has a high tolerance for inflation above target levels. The latest forecast shows that it will take until 2027 for inflation to fall back to the target value of 2%, a whole year later than previously predicted, but the guidance issued by the Fed is still to reduce rather than increase restrictions. Goldman Sachs added that the Fed's updated forecast is highly consistent with their expectations: Assuming that US tariffs peak in the fourth quarter of 2025, and the number of immigrants decreases to 1 million in 2025 and 500,000 in 2026, Goldman Sachs expects that real GDP growth in the US will slow to below 2% next year, with lagging effects appearing in 2026, further slowing real GDP growth, while core PCE inflation remains at 2.5%, and the unemployment rate approaches the current 4.2%. As for the Fed's rate cut path, Goldman Sachs predicts that there will only be two 25 basis point rate cuts in 2025, but there will continue to be rate cuts thereafter, until the rate reaches 2.6% by the end of 2026.