Why Fed Rate Cuts Could Be Pushed Back

Summary

Podcast Summary: Thoughts on the Market

Episode: Why Fed Rate Cuts Could Be Pushed Back
Date: March 26, 2026
Host: Matthew Hornbach (Global Head of MacroStrategy)
Guest: Michael Gapen (Chief U.S. Economist, Morgan Stanley)

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Episode Overview

This episode examines the implications of the March FOMC (Federal Open Market Committee) meeting for the U.S. economy and interest rates for the remainder of 2026. Matthew Hornbach and Michael Gapen discuss why the Federal Reserve is expected to delay rate cuts, the intense focus on inflation versus labor market issues in the Fed’s recent communications, the complexities presented by recent supply-side shocks (tariffs, oil prices), and implications for the U.S. Treasury market.

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Key Discussion Points & Insights

1. Fed Rate Cuts Likely Pushed Later in 2026

• Revised Outlook:
  • Morgan Stanley now expects rate cuts in September and December, rather than in June and September as previously forecasted.
  • The shift is driven by increased macro uncertainty and rising oil prices putting upward pressure on headline inflation.
  • Quote [00:36], Michael Gapen:

    "We previously thought rate cuts would come in June and September. We've slid those back to September and December… it will likely take the Fed longer to conclude that disinflation is occurring."

2. Singular Focus on Inflation at the FOMC Press Conference

• Press Conference Recap:
  • Out of approximately 23 questions, 18 were about inflation or prices, only 5 about labor markets.
  • Word count analysis shows a 5:1 ratio of inflation/oil terms to labor market terms.
  • Memorable quote [01:21], Michael Gapen:

    "By a 5 to 1 ratio, the press conference was dominated by fears or concerns around inflation, inflation expectations and oil prices. Whatever message the Fed was trying to send, it's hard to send either a neutral or a dovish message when nearly every question was about inflation."

3. Fed’s Strategy on Supply-Side Shocks: Tariffs and Oil Prices

• Powell’s Approach:
  • The Fed is hesitant to look through headline inflation from oil until it’s confident tariff-related inflation has abated.
  • Classical monetary policy wisdom suggests looking through supply-side shocks, but the Fed’s approach is now more cautious.
  • Quote [02:57], Michael Gapen (paraphrasing Powell):

    “…what we have to do is get through this tariff pass through to core goods first. That I can't even tell you whether or not we want to look through an increase in headline inflation until we get greater clarity that tariff pass through to core goods has ended.”

  • This step-wise caution "raises the bar" for a rate-cut decision.

4. Context of the Fed's Inflation Target History

• Added Pressure:
  • The Fed has missed its 2% inflation target for five years, increasing the complexity of justifying looking through new inflation shocks.
  • Quote [04:33], Michael Gapen:

    "To conclude that you can look through increases in headline inflation from oil … one of the conditioning factors there is that long run inflation expectations remain stable and well anchored over around the Fed's 2% target."

5. Market Reaction to FOMC Messaging

• Market Takeaways:
  • After the FOMC meeting, the market priced only a 50% chance of a December rate cut, at one point even briefly pricing in the possibility of a rate hike.
  • The reluctance to cut rates is rooted in the Fed's checklist approach—waiting to see both the end of tariff-related inflation and a firm anchoring of long-term expectations.
  • [05:19], Matthew Hornbach:

    "That really increases the chance the Fed doesn't ease at all this year."

6. Fed’s View on Inflation Expectations

• Fed’s Tolerance:
  • The Fed is comfortable with long-run inflation expectations where they are, viewing the slight increase post-COVID as a correction from previously too-low levels.
  • Current risk: Multiple shocks (COVID, tariffs, oil) may challenge this stability in consumer and business perceptions.
  • Quote [06:47], Michael Gapen:

    "As long as … long run inflation expectations are about where they are, I think the Fed's okay with that."

7. Labor Market Outlook

• General Equilibrium, Low Dynamism:
  • Immigration controls have dampened labor supply growth; hiring has slowed, but unemployment remains stable.
  • The labor market isn’t dynamic: average job growth is only 20-30,000 jobs monthly.
  • This stagnation, combined with potential demand side negatives from energy shocks, may eventually nudge the Fed toward easing.
  • Quote [07:54], Michael Gapen:

    “Yes, the labor market is in balance. But what concerns me and concerns us is it's not a very dynamic labor market… payroll growth close to zero doesn't feel good.”

8. U.S. Treasury Market Implications

• Performance & Hedge Value:
  • If the economy plays out as projected (delayed cuts, slow growth), U.S. Treasuries are likely to perform well and continue to serve as effective hedges against riskier assets.
  • Quote [09:45], Matthew Hornbach:

    “…U.S. treasuries, despite the recent sell off, have been behaving as good hedge securities for broader risky asset portfolios. So we certainly would expect the US treasury market to perform quite well in this scenario.”

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Memorable Quotes & Moments

• On the Fed’s reaction process:

  • Michael Gapen [02:57]:

    "I can't even tell you whether or not we want to look through an increase in headline inflation until we get greater clarity that tariff pass through to core goods has ended."

• On labor market stagnation:

  • Michael Gapen [07:54]:

    "Payroll growth close to zero doesn't feel good. Rates of turnover movement in and out of the labor market have slowed down."

• On market dread post-FOMC:

  • Matthew Hornbach [05:19]:

    “…the market had been pricing about a 50% probability that the Fed would deliver its only rate cut in December.”

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Notable Timestamps

• 00:36: Revision of Morgan Stanley’s rate cut forecast
• 01:21: Discussion of the near-singular focus on inflation at the press conference
• 02:57: The Fed’s cautious stance on supply-side shocks and rate cuts
• 04:33: The importance of long-term inflation expectations and the five-year miss
• 05:19: Market response and increased skepticism about easing
• 06:47: The Fed's view on inflation expectations post-pandemic
• 07:54: Analysis of labor market dynamics and lack of robustness
• 09:45: Expectations for U.S. Treasuries as a hedge and performance projection

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Tone & Style

The dialogue is sharp, analytical, and data-driven, offering clear explanations for sophisticated financial listeners but remaining accessible to a broader audience interested in Fed policy and market strategy. The conversation reflects Morgan Stanley’s disciplined, empirical approach, with a focus on both macroeconomic signals and financial market implications.

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Summary Prepared for Listeners and Readers Who May Have Missed the Episode

Transcript

[A]

Welcome to Thoughts on the Market. I'm Matthew Hornbach, global head of MacroStrategy.

[B]

And I'm Michael Gapen, Morgan Stanley's chief U.S. economist.

[A]

Today, the outcome of the March FOMC meeting and what it means for our economic and rates outlook for the rest of the year. It's Thursday, March 26th at 8:30am in New York. So Mike, as we expected, the Fed stayed on hold last week, the FOMC meeting and retained its easing bias. But what do you think the heightened macro uncertainty means for rate cuts this year?

[B]

Well, Matt, I think the answer is caution and probably rate cuts come later than earlier. So we've changed our view on the back of the FOMC meeting. We previously thought rate cuts would come in June and September. We've slid those back to September and December. The short answer here is I think with the rise in oil prices and at least some renewed upward pressure on headline inflation, it will likely take the Fed longer to conclude that disinflation is occurring. So I think they need more time and that obviously means the Fed pushes rate cuts out.

[A]

Is there anything about the press conference that, that struck you as being interesting?

[B]

Yeah, I think the almost near singular focus on inflation. So after the meeting was over and the press conference was done, we did a little deep dive into the transcript because that's what we do as economists who follow the Fed. And There were about 18 questions on inflation or prices. There were only five on labor markets. And if you do kind of a word count on inflation and oil related terms, that would have popped about 200 answers. If you looked at labor market terms, you would have gotten about 40. So by a 5 to 1 ratio, the press conference was dominated by fears or concerns around inflation, inflation expectations and oil prices. Whatever message the Fed was trying to send, I think it's hard to send either a neutral or a dovish message when nearly every question was about inflation. For me, I think the singular focus on inflation was what surprised me.

[A]

One of the questions that I think market participants, and I'm sure yourself expected Powell to be asked was about how the Fed would respond to this supply side energy shock that would raise inflation and whether or not the Fed would look through that type of supply side effect. How did you interpret his answer?

[B]

His answer was for me, a little more complicated than I thought it would be. You're right that it is kind of traditional monetary policy knowledge or views that you're supposed to look through. An increase in headline inflation from oil prices. History says in the US they have little effect on core inflation, very little second round effects. So you do, I think want to come into this event thinking we're primed to look through. But what he said was, well, wait for, first of all, what we have to do is get through this tariff pass through to core goods first. That I can't even tell you, I'm paraphrasing here. That I can't even tell you whether or not we want to look through an increase in headline inflation until we get greater clarity that tariff pass through to core goods has ended. So and this I think contributes to our view that it's going to take a longer time until the Fed's comfortable easing. Because. Because I think that raises the bar for a conclusion that disinflation is happening.

[A]

Right. So they want to first check the box on being past the tariff related inflation before they start to consider whether or not they look through the energy related inflation. And as a part of that question, the reporter sort of framed it as well, in the context of missing your inflation target for five years, how are you going to think about it? And he layered that into his answer as well.

[B]

They've missed their target for five years. I wasn't aware. Yes, no, that was the additional context which is to conclude that you can look through increases in headline inflation from oil. One of the conditioning factors there is that long run inflation expectations remain stable and well anchored over around the Fed's 2% target. So short run inflation expectations have moved higher just as they did when tariffs were implemented, just as they did during COVID So yes, there's a multiple kind of step box checking, to use your term, that the Fed needs to go to before it can say, okay, fine, we think disinflation is in place. I still think they can get there this year, but obviously that's a later than sooner kind of decision.

[A]

Absolutely. And I think in terms of the market response to the FOMC meeting and the press conference, it was that exchange with that reporter that was concerning to investors and they said, well, if the Fed first needs to see tariff related inflation pass and then they're going to consider whether or not to look through energy related inflation in the context of having missed their inflation target for 5 years, market participants said, well, gosh, that really increases the chance the Fed doesn't ease at all this year. And so at the end of that trading day, the market had been pricing about a 50% probability that the Fed would deliver its only rate cut in December. And of course the market has moved since the FOMC meeting. But that was my takeaway at least in terms of inflation expectations because this is so critical in terms of how the Fed and other central banks around the world who have slightly different mandates than the Fed does. How do you expect the Fed to think about inflation expectations later this year when perhaps they're actually considering whether or not to look through the energy price inflation in the context of what, what happened to longer run inflation expectations in the wake of the pandemic?

[B]

So my view on this and at least my takeaway from listening to Powell and prior press conferences and hearing other FOMC members, I think they feel that coming out of COVID yes, long run inflation expectations moved up, but they actually moved up for a good reason. I think they felt that long run inflation expectations were a little low going into Covid. So still generally consistent with 2% outcomes, but kind of on the downside. So a little increase in long run inflation expectations coming out of COVID I think they were okay with the risk now will be. Covid has been followed by a tariff price shock and an oil price shock. And in theory these are supply side shocks that shouldn't result in long run inflation. But you never know. Business and consumers may feel differently. So I think as long as they meaning long run inflation expectations are about where they are, I think the Fed's okay with that.

[A]

Right. You did mention that the labor market didn't come up all that much. What's your view on the labor market going into the end of the year?

[B]

Well, I think it's pretty similar to the way Powell characterized it, which is it is abundantly clear that immigration controls have had a strong effect on the labor market and reduced growth in labor supply. It's obvious also we've had a year now where hiring has come down. So on one hand the labor market. I'm an economist, so I have to say on the one hand, and on the other hand, on the one hand, the labor market is generally in balance. Low labor supply, low labor demand. The unemployment rate has been broadly unchanged, pretty stable since September. That's what Powell in the past has characterized as, quote, the curious balance. So yes, the labor market is in balance. But what concerns me and concerns us is it's not a very dynamic labor market. An economy the size of the US about 360ish million people or so. We're basically not adding many jobs every month. 20 to 30,000 if you kind of take a six month or so average is about all we're adding every month. That doesn't feel very robust. Rates of turnover movement in and out of the labor market have slowed down. And so I think you can say, yes, the labor market's in a general equilibrium, but payroll growth close to zero doesn't feel good. This is also why I think it's reasonable to expect rate cuts out of the Fed in the second half of the year. It can come either because disinflation happens, or higher oil prices can weigh on demand, slow consumer spending, delay business spending plans. If that happens, I think it'd be reasonable to think the unemployment rate may drift up a little. Not a lot, but enough to get the Fed thinking maybe we should give it some more support.

[A]

And I think if that's what we end up seeing out of the economy and out of the Fed, then the US treasury market is set up for a decent run into the end of the year. The market today isn't pricing many rate cuts at all to speak of. And in fact, at one point after the FOMC meeting, for a moment in time we were pricing rate hikes. But I think if we get that outcome for the U.S. economy and for Fed policy, I think investors in U.S. treasuries will be rewarded. And even if they're not rewarded in the way that they might expect or hope, the U.S. treasury market itself and the correlations that it has delivered vis a vis riskier assets like the equity market suggests that U.S. treasuries, despite the recent sell off, have been behaving as good hedge securities for broader risky asset portfolios. So we certainly would expect the US treasury market to perform quite well in this scenario. And so with that, Mike, I am afraid I will have to bid you adieu until the next FOMC meeting.

[B]

Thanks for having me on, Matt. It's great speaking with you.

[A]

Likewise, and thanks for listening. If you enjoy thoughts on the market, please leave us a review wherever you listen and share the podcast with a friend or colleague today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.