Fundamentals offer little relief from tightening expectations
US Economics Weekly
Markets may be overpricing Fed tightening, but fundamentals offer little reason to believe that yet.
US Economics Weekly | North America Fundamentals offer little relief
from tightening expectations
Key Takeaways
The rates market has been hit by a perfect storm in the direction of tighter fed policy and higher yields.
The market-implied path for Fed policy now brings the federal funds rate near the peak of the prior tightening cycle following the pandemic.
Our weighted-average policy path is more benign, and we expect fewer hikes than the market-implied path.
However, our expected policy path does not diverge from the market until after 1Q 27.
We are hard-pressed to see fundamental catalysts for more dovish Fed expectations any time soon. If so, hawkish sentiment may remain in place.
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Fundamentals offer little relief from tightening expectations
A perfect storm in the rates market
The rates market is caught in a perfect storm. Resilient growth, sticky inflation, concerns over government restrictions in energy markets, a newly hawkish Fed, corporate issuance, persistent fiscal deficits, and questions surrounding a Treasury that has become less regular and predictable have all combined to push Treasury yields significantly higher. Since March, the yield on the 2y, 5y, and 10y US Treasury note has risen between 120150bp. Much of this rise has come from expectations for monetary tightening. Following the Fed's 25bp rate hike in September, markets are pricing in almost 100bp more in additional policy rate increases. We do not see the Fed delivering this much policy rate tightening in our baseline, but we are hard pressed to see any fundamental drivers that will make this clear to markets for some time.
The Fed path certainly contains hikes, but how many is uncertain
With the understanding that financial markets price a continuum of outcomes, our conversations with clients in recent weeks have centered on three outcomes. The first looks like the median forecast from the September FOMC meeting: a Fed that recalibrates policy by raising its policy rate 50-75bp to lean against second round effects from supply shocks on inflation. Since monetary policy is not well-equipped to deal with supply shocks, this scenario assumes the committee accepts relatively slow convergence to the 2% target.
A second scenario is a more hawkish Fed that desires a much quicker return to 2%. Instead of leaning against second round effects from higher energy prices, the Fed reacts to the direct effects of higher energy prices on inflation. Advocates of this view point to Chair Warsh's comments in the press conference which strongly linked geopolitics, inflation, and a need for restriction. Since the Fed cannot control oil prices, it would need to constrain domestic demand more forcefully to achieve faster convergence. In our view, the most likely transmission mechanism for monetary policy in this scenario would come through lower asset prices and softer consumption. This would likely require the Fed to take the target range for the federal funds rate back toward 2023 highs as the thinking goes, or about 150bp in total rate hikes.
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A third possibility is an upshift to an "animal spirits" demand-driven economy. In this outcome, the AI investment boom generates feedback effects that broadens the expansion, improves economic growth, lifts employment, and keeps inflation firm. In response, the Fed takes the target range for the funds rate up 150bp and back toward 2023 highs, similar to the scenario above, but for different reasons. Inflation converges more slowly to the target, at a similar pace as in the first scenario.
Our revised outlook for the US economy is based on a permanent oil risk premium and sticky inflation. In our baseline outlook the Fed hikes two more times (75bp in total) and maintains that rate through the end of 2027. Our four alternative scenarios for the US economy (see Exhibit 29 ) include "animal spirits", faster disinflation, AI-driven labor market displacement, and a recession driven by much higher oil prices ( Exhibit 2 ). Applying our subjective probabilities to those scenarios yields a weighted average policy rate path below the market path ( Exhibit 3 ).
In addition to our weighted average across all of our scenarios, we add a weighted average for our two scenarios that contain rate hikes. This may be a more relevant comparison against the current market-implied path for policy since it re-weights our subjective probabilities around our baseline with 75bp of total hikes and our animal spirits upside scenario with 150bp of total rate hikes. Doing so results in the "hikes only" line in Exhibit 3 .
Too many hikes, but no near-term catalyst
So what can we say from this? In our baseline, we still see growth as resilient but with limited evidence that AI-related spending is leading to an overheating economy. As we have noted, AI-related spending has a heavy import content and may be fueling positive output gaps abroad more than at home. Some further monetary restriction should help
Idea keep inflation heading in the right direction, and our equity analysts project the growth rate of hyperscaler capex spending will slow in 2027. The second derivative of this spending is what matters for GDP growth and any slowdown should reduce overheating concerns. If all this proves correct, then we think the market is pricing in too many Fed hikes. That said, the gap between our expected policy rate path and the market's does not diverge until after 1Q 27.
Our main takeaway is that fundamental catalysts that could tilt market expectations in favor of fewer expected rate hikes from the Fed – whether it's successive inflation prints that show progress toward the target, a resolution to the ongoing conflict in the Middle East that brings relief to energy markets, decelerating AI-related spending that would temper upside growth risks – do not appear right around the corner. We are hard-pressed to see a near-term fundamental catalyst that can change the current narrative. If so, then the adverse winds buffeting the rates market and federal funds futures are likely to
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Oil Tracker: Running Out of Buffers
Our baseline outlook for the US economy assumes a permanent oil risk premium. The renewed pressure on energy prices has dragged the world into the seventh month of this prolonged energy price shock. Historically, episodes of acute geopolitical or physical supply disruption have mostly lasted 3–6 months, with the notable exception of the 1978–79 oil shock and its aftermath. As buffers such as higher U.S. exports, weaker Chinese imports, and ample inventories begin to fade, we update our oil tracker to highlight developments and trends that matter for U.S. economic growth.
The latest data suggest that crude oil inventories in the Strategic Petroleum Reserve (SPR) have fallen further, while both U.S. crude oil imports and exports have remained on an upward trend. Crude oil prices have continued to rise, while diesel margins have widened further.
Prices: higher crude spot prices, wider diesel margins
The latest spot prices, as of September 22, were $96.41 per barrel for WTI in Cushing, Oklahoma, and $114.89 per barrel for Brent in Europe. We convert diesel and gasoline prices to a per-barrel basis for a better comparison: diesel was at $216.47 per barrel, while gasoline was at $178.95 per barrel. The gap between gasoline and crude oil prices has remained broadly unchanged, whereas the gap between diesel and crude oil prices has continued to widen since early July.
We think this divergence is partially driven by refineries around the Strait of Hormuz reducing their demand for crude oil as disruptions constrain their ability to ship refined products out of the region. At the same time, these disruptions have reduced the effective supply of diesel to the global market, putting upward pressure on diesel prices relative to crude oil.
Quantities: Falling SPR stocks, stable net imports, rising production
As of September 22, U.S. commercial crude oil stocks, which represent the EIA's estimate of how many barrels of crude oil are physically held in U.S. storage at period-end, remained broadly unchanged from a week earlier. Meanwhile, crude oil stocks in the Strategic Petroleum Reserve (SPR) continued to fall to around 284.6 million barrels, the lowest level since April 1984.
The Energy Department said the SPR's minimum inventory is determined by "cavern mechanics," which, when applied across the full system, translates to a conservative operational minimum of about 70 million barrels. If the SPR continues to decline at a pace of roughly 30 million barrels every four weeks, inventories would approach this operational minimum by March 2027. Using data on U.S. domestic crude oil production, net imports, and SPR drawdowns, we estimate monthly U.S. crude oil use at around 520 million barrels. A monthly SPR drawdown of 30 million barrels therefore accounts for only about 6% of U.S. crude oil use.
Both U.S. crude oil imports and exports have been on an upward trend since July, though they have risen at a similar pace, keeping net imports broadly unchanged. Canada remains the largest source of U.S. crude oil imports. Imports from Venezuela have risen at an
Idea average monthly rate of 14%, although the overall volume remains too small to have a meaningful impact so far. Imports from Saudi Arabia were minimal from May through August, reflecting constraints around the Strait of Hormuz, but appear to have improved moderately in September.
U.S. domestic crude oil production has also continued to rise, while U.S. refineries have increased their utilization, helping to support domestic supply amid ongoing disruptions.
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Financial conditions: The Fed Awakens
Following the 25bp rate hike in September and the shift into an "oil risk premium" baseline, we reset our financial conditions index to September 15 2026, the day prior to the September FOMC meeting, to track our FRB/US-based measure of financial conditions in this new hiking cycle. As of the September 24 market close, financial conditions were about one hike tighter than they were before the September FOMC meeting.
The index aims to capture how changes in asset prices weigh on future economic activity. It includes five daily variables: the 10-year Treasury yield, S&P 500 returns, the corporate BBB credit spread, the valuation of the U.S. dollar, and the price of oil. These are aggregated based on their estimated growth elasticities relative to the federal funds rate using the Federal Reserve's FRB/US model. As a result, the index can be interpreted as the equivalent change in the federal funds rate, expressed in basis points, required to generate a similar effect on economic activity.
Since the day before the September FOMC meeting, the easing in financial conditions has been equivalent to about a 27bp hike in the federal funds rate, driven primarily by a higher 10-year Treasury yield and USD appreciation. Equity returns and BBB credit spreads have offset some of the tightening.
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The effective tariff rate, tariff receipts, and refunds
Tariffs averaged 6.7% over May-July, and we expect that it will rise to near 10%
USTR's final forced-labor Section 301 action was broadly in line with our expectations. Effective July 24, the agency imposed additional tariffs on imports from 60 economies, setting a 10% duty on economies that have adopted, partially adopted, or committed to adopt a forced-labor import prohibition and a 12.5% duty on most others. The final action also preserves several key carve-outs, including goods already subject to Section 232 tariffs, USMCA-compliant imports, and a range of general and country-specific product exemptions. Overall, both the tariff structure and the principal exemptions closely resemble the proposal, reinforcing our expectation that Section 301 would serve as the broad country-level tariff floor. We continue to expect that the statutory effective tariff rate will converge toward ~10% by year-end. In the July 2026 data, the effective tariff rate is estimated at ~6.5%. Over the past three months of detailed trade data (May, June and July), the tariff rate has averaged 6.7%. There has been a recent escalation of trade disputes with Canada, and section 338 tariffs have been applied on approximately $20bn of Canadian imports. However, for now, we do not expect this to meaningfully affect our year-end tariff estimates.
tariff rate on all imports over Jan - May 2026.
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Tariff refunds represent cash returned to importers when customs duties were previously overpaid or later determined to be refundable, for different reasons, including a tariff exclusion or court-ordered refund or a drawback claim tied to goods that are exported or destroyed. The process generally runs through CBP, where importers or brokers submit the relevant claim and supporting documentation; CBP then reviews eligibility, confirms the entry and status, and certifies approved refunds for payment. In Treasury cash-flow data, we monitor these payments at high frequency through CBP-related withdrawals in the Daily Treasury Statement. We interpret this as a tariff-refund proxy.
3Q GDP tracking remains at 2.5%
This week's housing data left our 3Q GDP tracking unchanged at 2.5%. For a second quarter in a row, it appears that demand is running faster than output. While we estimate 3Q GDP rises at a 2.5% q/q annual rate, we estimate private final domestic final purchases (PDFP) rises at a 3.7% pace, with booming business investment and consumption growth of nearly 3%. In 2Q, similarly, GDP rose 1.5% but PDFP rose 4.2%.
The Atlanta Fed's estimate was unaltered at 5.1%. Its faster pace mostly reflects two categories. Services consumption, at 4.6% growth, is a point and a half higher than ours, contributing an extra 0.7 pct pt to GDP growth. And the Atlanta Fed also is estimating that inventories add 2.0 pct pts to growth in 3Q, 1.7 pct pt more than we estimate. The New York Fed nowcast was unaltered at 2.3%.
Exhibit 17: The effect of incoming data on our US GDP tracking estimate
Date
Data release
Aug 7
Baseline
Aug 14
Retail sales and CPI
Aug 18
Housing starts and permits
Aug 25
New home sales
Aug 26-27
Trade and durables
Aug 28
2Q consumption
Sep 3
Trade detail
Sep 10
Existing home sales
Sep 16
Retail sales
Sep 17
Housing starts and permits GDP tracking Contribution to GDP growth (pp)
Note: Our GDP tracking estimate is distinct from our official published GDP forecast. It reflects the mechanical aggregation of monthly activity data that feed directly into the BEA's calculation. Where data releases have implications for the tracking components, cells have been bolded. Final sales is GDP less inventories. Source: Morgan Stanley Research
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Exhibit 19: Our tracking vs. the Atlanta Fed tracking
Morgan Stanley
Atlanta Fed
Difference q/q%, ar contrib q/q%, ar contrib contrib, pts
GDP
2.5
5.1
-2.6
Final sales
2.2
2.2
3.0
3.1
-0.9
Final sales to dom. purchasers
3.3
3.4
4.3
4.4
-1.0
Private
3.7
3.2
4.7
4.0
-0.9
Consumption
2.9
2.0
4.1
2.8
-0.8
Goods
2.8
0.6
3.2
0.7
-0.1
Services
3.0
1.4
4.6
2.1
-0.7
Residential investment
-1.4
-0.1
-4.7
-0.2
0.1
Equipment investment
15.0
0.9
17.4
1.0
-0.1
Nonres structures
-3.0
-0.1
2.2
0.1
-0.1
Intel. Property
8.0
0.5
6.4
0.4
0.1
Government
1.5
0.2
2.3
0.4
-0.2
Exports
-6.0
-0.7
-2.7
-0.3
-0.4
Imports
4.0
-0.6
7.5
-1.1
0.5
Net exports
-1.3
-1.4
0.1
Inventories
0.3
2.0
-1.7
Source: Federal Reserve Bank of New York, Morgan Stanley Research
Data review & preview
Review of past week's data
Exhibit 20:
Monday 21 Sept
Data
6:30 AM
Fed's Goolsbee Speaks About Monetary Policy
8:30 AM
Chicago Fed Nat Activity Index
Tuesday 22 Sept
Data
8:15 AM
ADP Weekly Employment Change
8:30 AM
Philadelphia Fed Non-Manufacturing Activity
10:00 AM
Richmond Fed Manufact. Index
10:05 AM
Fed's Williams Gives Keynote Remarks
10:20 AM
Fed's Jefferson speaks on Treasury Market functioning
1:00 PM
Fed's Barkin speaks
Wednesday 23 Sept
Data
7:00 AM
MBA Mortgage Applications
9:45 AM
S&P US Manufacturing PMI
9:45 AM
S&P US Services PMI
10:05 AM
Fed's Barr speaks on housing
Thursday 24 Sept
Data
4:10 AM
Fed's Williams Speaks During Moderated Discussion
8:00 AM
Fed's Barkin speaks
8:30 AM
Current Account Balance
8:30 AM
Initial Jobless Claims
8:30 AM
Continuing Claims
8:50 AM
Fed's Hammack Delivers Opening Remarks at Inflation Conference
10:00 AM
New Home Sales
10:00 AM
New Home Sales m/m
10:10 AM
Fed's Paulson Speaks At Fintech Conference
11:00 AM
Kansas City Fed Manf. Activity
4:30 PM
Fed balance sheet (H.4.1)
Friday 25 Sept
Data
5:15 AM
Fed's Williams Participates in Policy Panel
8:30 AM
Durable Goods Orders
8:30 AM
Durables Ex Transportation
8:30 AM
Cap Goods Orders Nondef Ex Air
8:30 AM
Cap Goods Ship Nondef Ex Air
10:00 AM
U. of Mich. Sentiment
10:00 AM
U. of Mich. 5-10 Yr Inflation
11:00 AM
Kansas City Fed Services Activity
2:00 PM
Fed's Hammack Participates In Policy Panel Discussion
4:15 PM
Commercial bank balance sheets (H.8)
Source: Bloomberg, Morgan Stanley Research forecasts
Preview of upcoming data
Exhibit 21: Monday
Monday 28 Sept
Data
10:30 AM
Dallas Fed Manf. Activity
Source: Bloomberg, Morgan Stanley Research forecasts
Idea
Period
Forecast
Consensus
Prev
Actual
Aug
0.0
-0.1
-0.04
Period
Forecast
Consensus
Prev
Actual
5-Sep
20
Sep
-8.7
-10.6
-22
Sep
2.0
4.0
-2
0.0
Period
Forecast
Consensus
Prev
Actual
18-Sep
-1.5
Sep P
53.7
53.9
57
Sep P
55.9
56.5
58.7
Period
Forecast
Consensus
Prev
Actual
2Q
-245.0
-258.1
-226.8
-246.0
19-Sep
200
200.0
196
197
12-Sep
1750
1740.0
1730
1719
Aug
660
616
607
684
Aug
-1.5
1.3
-10.5
6.4
Sep
8.0
10.0
14
Period
Forecast
Consensus
Prev
Actual
Aug P
0.0
-0.3
1.1
Aug P
0.6
0.6
0.4
Aug P
0.7
0.5
0.0
Aug P
0.7
0.7
1.2
Sep F
47.5
47.8
Sep F
3.4
3.4
Sep
-3.0
Period
Forecast
Consensus
Prev
Sep
7.2
11.6
Exhibit 22: Tuesday
Tuesday 29 Sept 9:00 AM 9:00 AM 10:00 AM 10:00 AM 10:00 AM 1:00 PM 2:00 PM
Source: Bloomberg, Morgan Stanley Research forecasts
JOLTS. Job openings have rebounded, and the vacancy rate ratio of job openings to the number of unemployed has bounced back above 1.0. At its new, higher level, it no longer raises risks that the unemployment rate rises more sharply.
Exhibit 23: Wednesday
Wednesday 30 Sept
Data
7:00 AM
MBA Mortgage Applications
8:15 AM
ADP Employment Change
8:30 AM
Retail Inventories m/m
8:30 AM
BEA Releases Annual Revisions to GDP and Personal Income
8:30 AM
Personal Income
8:30 AM
Personal Spending
8:30 AM
Real Personal Spending
8:30 AM
PCE Price Index m/m
8:30 AM
PCE Price Index y/y
8:30 AM
Core PCE Price Index m/m
8:30 AM
Core PCE Price Index y/y
8:30 AM
GDP Annualized q/q
8:30 AM
Personal Consumption
8:30 AM
Core PCE Price Index q/q
8:30 AM
Advance Goods Trade Balance
8:30 AM
Wholesale Inventories m/m
9:45 AM
MNI Chicago PMI
1:30 PM
Fed's Barkin Gives Welcome Remarks at Rural America Conference
3:25 PM
Fed's Cook Speaks at Investing in Rural America Conference
5:15 PM
Fed's Goolsbee Gives Keynote Address
Source: Bloomberg, Morgan Stanley Research forecasts
PCE prices. We expect core PCE to rise 0.25% m/m in August, with acceleration in both core goods and core services inflation, while headline PCE increases 0.34% m/m. Our estimates incorporate our best assessment of the upcoming PCE revisions.Including the effects of the revisions, we expect core PCE inflation to run at 3.26%, 3.18%, and 2.73% on a 12-, 6-, and 3-month annualized basis, respectively, compared with 3.19%, 3.32%, and 3.41% in July. See forecast details here: U.S. Data Pulse: CPI: August CPI: A hawkish surprise (11 Sep 2026)
Personal income and spending. We expect real personal spending rose 0.4% m/m in August, with goods up 1.2% and services up 0.1%. This services expectation includes a drag of about a tenth as World Cup spending from June and July is not repeated. We expect nominal personal income rose 0.4% m/m, with labor compensation up a stronger 0.5%. Real disposable personal income is flat on the month with the re-acceleration in oil prices, and the saving rate falls from 3.0% in July to 2.6% in August.
Trade balance in goods. Price changes alone would suggest a slight widening of the trade gap in goods in August. However, we expect that real imports fall and real exports rise by about 2 1/2% m/m, and the overall trade gap narrows sharply to $110bn. That said, capital
Idea
Conf. Board Consumer Confidence
Fed's Goolsbee Speaks in Moderated Discussion
Period
Forecast
Consensus
Prev
25-Sep Sep
70
38
Aug
0.7
0-Jan Aug
0.4
0.5
0.4
Aug
0.7
0.9
0.2
Aug
0.4
0.6
0.0
Aug
0.4
0.2
Aug
3.7
3.7
Aug
0.3
0.2
Aug
3.3
3.3
2Q T
1.5
1.5
1.5
2Q T
3.4
3.4
3.4
2Q T
3.6
3.6
Aug
-110.0
-113.9
-118.8
Aug P
1.3
Sep
51.2
47.1 goods imports have repeatedly surprised with their strength.
GDP revision. The annual revision will cover from 2021 onward. As usual, the BEA will incorporated updated source data for spending and income. More important to the current macro questions will be the revisions to PCE prices. In particular, BEA is changing how it estimates prices for portfolio management services, legal services, and computer software. As well as potentially shifting the recent pace of core PCE inflation, these could alter (to the same extent, in the opposite direction) estimates of real spending.
Exhibit 24: Thursday
Thursday 01 Oct
Data
Total Vehicle Sales
5:30 AM
Challenger Job Cuts y/y
8:30 AM
Initial Jobless Claims
8:30 AM
Continuing Claims
9:05 AM
Fed's Barkin, Collins, Schmid on Panel About Rural America
9:45 AM
S&P Manufacturing PMI
10:00 AM
ISM Manufacturing
10:00 AM
Construction Spending m/m
6:45 PM
Fed's Logan Speaks At Eleventh District Appreciation Event
4:30 PM
Fed balance sheet (H.4.1)
Source: Bloomberg, Morgan Stanley Research
Jobless claims likely inch up to 200k, still an extremely low level and below recent months.
Manufacturing ISM. September manufacturing surveys so far suggest resilient manufacturing activity. Demand remains strong, and labor demand continues to expand. Supplier delivery times have lengthened at a faster pace, while input prices have accelerated sharply. We expect similar patterns in the ISM. We are tracking the September ISM Manufacturing PMI at 54.5, little changed from 54.6 in August.
Construction spending. We forecast a 0.2% decline led by pullback in single-family building. However, we expect that with the upward revision to August housing starts, August construction spending will be revised from its currently reported -0.5% to about 0.3%.
Exhibit 25: Friday
Friday 02 Oct
Data
8:30 AM
Change in Nonfarm Payrolls
8:30 AM
Change in Private Payrolls
8:30 AM
Average Hourly Earnings m/m
8:30 AM
Average Weekly Hours All Employees
8:30 AM
Unemployment Rate
8:30 AM
Labor Force Participation Rate
10:00 AM
Factory Orders
4:15 PM
Commercial bank balance sheets (H.8)
Source: Bloomberg, Morgan Stanley Research
Employment report. Please see our Employment Report Preview.
moves sideways at 4.1%, on the verge of a 4.2%, as LFPR inches up. Average hourly earnings remain slow, rising 0.2%m/m and 3.1%y/y.
Idea
Period
Forecast
Consensus
Prev
Sep
16.2
16.6
16.8
Sep
-38.5
26-Sep
200
197
19-Sep
1730
1719
Sep F Sep
54.5
55.0
54.6
Aug
-0.5
Period
Forecast
Consensus
Prev
Sep
65
100
162
Sep
75
88
127
Sep
0.2
0.3
0.3
Sep
34.4
34.3
34.4
Sep
4.1
4.1
4.1
Sep
61.6
61.6
Aug
0.9
Idea
Our forecast reflects continued strong labor demand, with only limited reversal of the industry payrolls that were above trend in August. Despite resilience in payrolls, the unemployment rate moves sideways (or up) as labor force participation moves sideways (or up).
The Fed's clearly not concerned about faltering labor demand. But a drop in the unemployment rate below 4.0% would further raise the chance of an October rate hike.
Data calendar
Exhibit 26: September 28 - October 9
Monday
TUESDAY
28
29
30
Dallas Fed Manf. Activity (Sep, 10:30
Home Prices (Jul, 9 AM)
MBA Mortgage Applications (Wk of
AM)
9/25, 7 AM)
Conf. Board Cosumer Confidence (Sep, 10 AM)
Fed's Barkin Speaks (1:30 PM)
ADP Employment Change (Sep, 8:15 AM)
JOLTS (Aug, 10 AM)
Personal Income and Spending, PCE
Dallas Fed Services Activity (Sep,
Prices (Aug, 8:30 AM)
10:30 AM)
GDP (2Q T, 8:30 AM)
Fed's Goolsbee Speaks (1 PM)
Advance Goods Trade Balance,
Treasury Buyback (TIPS 1Y-10Y,
Wholesale and Retail Inventories max $750 mil, 1:40 PM)
(Aug, 8:30 AM)
Fed's Williams Speaks (2 PM)
MNI Chicago PMI (Sep, 9:45 AM)
Fed's Barkin Speaks (1:30 PM)
Fed's Cook Speaks (3:25 PM)
Fed's Goolsbee Speaks (5:10 PM)
Fed's Kashkari Speaks (6 PM)
S&P Services PMI (Sep F, 9:45 AM)
ADP Weekly Employment Change
MBA Mortgage Applications (Wk of
(Wk of 9/19, 8:15 AM)
10/2, 7 AM)
ISM Services (Sep, 10 AM)
Trade Balance (Aug, 8:30 AM)
NY Fed 1-Yr Inflation Expectations (Sep, 11 AM)
3-Year Notes Auction (1 PM)
10-Year Notes Auction (1 PM)
Treasury Buyback (Nom Cpn 2Y-3Y,
FOMC Meeting Minutes (2 PM) max $4 bil, 1:40 PM)
Consumer Credit (Aug, 3 PM)
Fed's Logan Speaks (7 PM)
Manheim Used Vehicle (Oct, 9 AM)
Note: For updates post-publication of the Treasury Auction Schedule, see here. Source: Bloomberg, Morgan Stanley Research
Idea
WEDNESDAY
THURSDAY
FRIDAY
Challenger Job Cuts (Sep, 5:30 AM)
Employment Report (Sep, 8:30 AM)
Jobless Claims (Wk of 9/26, 8:30 AM)
Factory Orders (Aug, 10 AM)
Fed's Barkin, Speaks (9:05 AM)
Durable Orders (Aug F, 10 AM)
S&P Manufacturing PMI (Sep F, 9:45 AM)
ISM Manufacturing (Sep, 10 AM)
Construction Spending (Aug, 10 AM)
Treasury Buyback (Nom Cpn 10Y20Y, max >=$4 bil, 1:40 PM)
Fed's Cook Speaks (3:30 PM)
Fed's Logan Speaks (6:45 PM)
Omdia Total Vehicle Sales (Sep)
Jobless Claims (Wk of 10/3, 8:30 AM)
U. of Mich. Consumer Sentiment (Oct P, 10 AM)
Wholesale Trade and Inventories (Aug, 10 AM)
30-Year Bond Auction (1 PM)
Treasury Buyback (Nom Cpn 20Y30Y, max >=$4 bil, 1:40 PM)
US economic outlook
Exhibit 27: Morgan Stanley forecasts
4Q/4Q % change 2025A
Real GDP
2.0
Final Sales 1
2.2
Final Domestic Demand 2
1.8
Final Private Domestic Demand 3
2.4
Personal Consumption Expenditures
2.1
— Goods
1.4
— Services
2.4
Nonresidential Fixed Investment
5.6
— Structures
-5.5
— Equipment
9.6
1) GDP less contribution from inventory investment 2) GDP less contributions from inventory investment and trade 3) GDP less contributions from inventory investment, trade, and the government sector. (Private final consumption plus investment.) Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Federal Reserve, Census Bureau, Treasury Dep't, Morgan Stanley Research forecasts
Idea
Quarterly % change, annual rate (unless otherwise noted)
2026E
2027E
1Q26A
2Q26A
3Q26E
4Q26E
1Q27E
2Q27E
3Q27E
4Q27E
2.1
2.3
2.1
1.5
2.5
2.5
2.1
2.3
2.4
2.4
2.2
2.1
1.9
2.2
2.1
2.4
2.0
2.1
2.2
2.2
2.8
2.5
2.2
3.3
3.3
2.3
2.3
2.5
2.7
2.7
3.0
2.7
1.7
4.2
3.7
2.5
2.4
2.7
2.8
2.8
2.2
1.8
0.5
3.4
2.9
1.9
1.5
1.8
2.0
2.0
2.1
1.1
0.5
4.3
2.8
1.0
0.5
1.0
1.3
1.3
2.2
2.2
0.5
3.1
3.0
2.3
1.9
2.2
2.3
2.3
8.4
7.1
10.6
8.5
8.7
5.9
7.1
7.1
7.1
7.2
-3.1
2.0
-4.7
-1.8
-3.0
-3.0
2.0
2.0
2.0
2.0
13.0
9.0
15.8
13.6
15.0
8.0
9.0
9.0
9.0
9.0
US Outlook Scenarios
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Exhibit 29: Morgan Stanley US Economics baseline and alternative outlooks for the US Economy: 2026, and 2027
Aggregate Demand Shock: Animal Spirits
Rapid Disinflation (10%)
(30%)
Elevated wealth supports consumption and
High oil prices act as a tax on consumption
"animal spirits" keep business spending near-term, though with slightly more rebound
GDP growth elevated. GDP grows 3.0% in 2027, 0.5-1.0pp in mid-to-late 2027. Real growth rises to 2.6% faster than the baseline.
(4Q/4Q) in 2027.
Average monthly payroll gains are slightly stronger vs the baseline, around 60k next
Stronger demand results in tighter labor year. Labor demand remains soft on markets. The unemployment rate falls to geopolitical uncertainty. Less immigration
Labor markets
3.9% in 2026 and 3.5% in 2027.
means a lower breakeven rate of hiring. The unemployment rate finishes 2027 unchanged vs 2026, around 4.2%.
High inflation in 2026 dissipates in 2027.
Inflation pressures step-up due to demand-
Energy prices push headline PCE inflation to side pressures. Headline inflation is 3.8% in
3.4% 4Q/4Q in 2026. Headline and core PCE
2026 and 2.8% in 2027. Core PCE inflation decelerate to 2.0% and 2.3% 4Q/4Q in 2027
Inflation firms through Q1 27, prompting Fed hikes, as the oil shock fades. Energy is a headline which subsequently slow inflation.
story with no important second-round effects on core.
The Fed hikes once more in December, but
Hikes to counter inflation. The Fed raises with oil pressures abating, disinflation is rates by 150bp in total to 5.00-5.25%, more faster and the Fed does not need to tighten
Federal reserve policy than reversing the 75bp in pre-emptive cuts to further. They cut twice in 2H27, to a terminal support the labor market in 2025.
rate of 3.5-3.75%.
Better than expected equity market returns
Faster disinflation results in more of a and a rebound in labor markets boost rebound in real income, while policy is less of consumption to around 3.0% in 2027. Uppera constraint than in the base case. By mid-
Consumer spending income consumers drive much of the
2027, we start to see some broadening out.
spending, but nominal wage growth supports
Real consumption growth is similar in 2027 low- and middle-income spending.
as 2026, around 2.1%.
Similar to the baseline. AI-related spending remains robust, while AI adoption rates rise
Business spending broadens out beyond AI,
Nonresidential fixed and firms realize productivity gains.
due to animal spirits and fiscal support.
investment
Broadening out in non-AI sectors continue, perhaps at a slower pace. Housing remains "stuck", but activity picks up slightly versus the base case on stronger real
Stronger growth is balanced by higher rates.
income growth and less restrictive policy.
Residential investment
Housing activity remains subdued.
Residential investment grows modestly in 2027. Imports are strong with somewhat stronger demand than the baseline , thus a larger drag
Imports are strong with strong demand, on GDP. Imports rise 5.0% in 2027. Exports resulting in a larger drag on GDP and a wider
Net trade rise 1.8%. Net trade subtracts 0.4pp from trade deficit.
growth in 2027. The fiscal impulse in the OBBBA is
Fiscal multipliers are higher than in the neutralized by higher gasoline prices. The baseline, resulting in higher contribution to midterm elections bring divided government,
Fiscal policy growth. With stronger growth, fiscal deficits leading to budget gridlock and large deficits decline.
at about 6.0% of GDP.
Credit conditions loosen somewhat on the
Geopolitical uncertainty combined with heels of stronger growth and animal spirits.
consumer resilience mean conditions are
Credit conditions
Bank lending accelerates.
steady over the forecast horizon.
Productivity rises faster than in the baseline
Similar productivity growth as the baseline, in 2027. Productivity gains are from higher
Productivity growth even with stronger employment growth.
output, not less employment.
Confidence of households and business
Confidence rebounds across the course of
Consumer and business the year, and further in 2027.
low labor demand, high inflation, and elevated confidence uncertainty.
Source: Morgan Stanley Research forecasts
Baseline: Oil Risk Premium/Sticky Inflation
(45%)
Key Forecasts
Oil prices reamining near $100/bbl in 4Q and 1Q weigh on growth near-term. Real GDP rises 2.3% in 2027 (4Q/4Q), though private final domestic demand decelerates slightly vs 2026.
The "curious balance" continues. Average monthly payroll gains average around 50k next year. Labor demand remains soft on geopolitical uncertainty. Less immigration means a lower breakeven rate of hiring. The unemployment rate finishes 2026 at 4.2% and 2027, a tenth higher vs 2026.
Two more years of above-target inflation. Energy prices push headline PCE inflation to 3.7% 4Q/4Q in 2026, while core accelerates to 3.2% on tariff push, the AI demand push, and second round effects from the oil shock. Headline and core PCE decelerate to 2.4% and 2.7% 4Q/4Q in 2027 as the inflationary effect of the oil shock fades.
Inflation remains sticky, leading to two more 25bp hikes in Dec 2026 and Mar 2027. The Fed then pauses there at 4.25%-4.5% for the remainder of 2027.
Key Forecasts Consumption has been resilient through the oil shock. Still soft real income growth and tighter policy continue to weigh on spending, especially for low- and middle-income consumers. Wealth is an offset, supporting the high-end. Consumption slows modestly to 1.8% in 2027.
AI-related spending remains robust, leading nonresidential fixed investment to moderate only modestly to 7.1% in 2027. AI adoption rates rise and firms realize productivity gains.
Housing remains "stuck" due to low affordability and limited inventory, which higher rates only reinforce. Residential investment is flat in 2027 after declining in 2026.
Imports rise 4.5% in 2027 after strong 7.6% growth in 2026. Exports rise 1.8% in 2027 after 3.0% in 2026. Net trade subtracts 0.3pp from growth next year .
Higher gas prices more than offset the growth effects of the OBBBA. The midterm elections bring divided government, leading to budget gridlock and large deficits at about 6.3% of GDP.
Geopolitical uncertainty combined with consumer resilience mean conditions are steady over the forecast horizon.
Productivity rises 1.8% in 2027, with a modest boost from AI.
Confidence of households and business low labor demand, high inflation, and elevated uncertainty.
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