Leading Wall Street investment banks have issued conflicting forecasts regarding the pace of the U.S. Federal Reserve's (Fed) future interest rate cuts. While Morgan Stanley and UBS anticipate significant rate cuts starting in the first half of next year, Goldman Sachs expects the cuts to be about half as large and to occur later. The Fed, which has held rates steady for two consecutive meetings, is scheduled to release a new dot plot in December.
On the 13th (local time), investment bank UBS projected in a memo to investors that the Fed could begin cutting rates as early as March next year. As a recession takes hold, the current rate of 5.25-5.5% is expected to fall to a range of 2.5-2.75% by the end of next year, and further down to 1.25% by early 2025. UBS Chief Strategist Banu Baweja stated, "Inflation is normalizing rapidly. By March 2024, the Fed will be facing very high real interest rates," anticipating a substantial easing stance going forward.
UBS’s scenario, which forecasts a massive 275 basis points (1bp=0.01 percentage point) cut within next year alone, is very aggressive compared to the Fed’s dot plot interest rate path and other investment banks. This outlook is based on the assumption that the U.S. economy will enter a recession starting in the second quarter of next year. UBS referenced the past 30 years, noting that central banks of the top 10 countries excluding Japan have cut rates by an average of 320 basis points over 15 months during easing cycles, and predicted that "(next year) central banks excluding Japan will ease more aggressively than the market expects."
Morgan Stanley also expects significant rate cuts starting next year. The economic analysis team led by Chief Economist Ellen Zentner forecasted in their 2024 economic outlook report released the previous day that the Fed would begin cutting rates in June next year. They expect another cut in September, followed by rate reductions at every meeting in the fourth quarter. Under this scenario, the median interest rate by the end of 2025 would be 2.375%.
However, unlike UBS, Morgan Stanley’s forecast is not based on a recession scenario. They anticipate an economic slowdown severe enough to warrant large rate cuts. Morgan Stanley estimates that the U.S. real GDP growth rate will be only 1.4%, and the unemployment rate will rise to 4.3%. This implies slower growth (1.8%) and higher unemployment (4.1%) than the Fed’s projections. Chief Economist Zentner noted, "With high interest rates persisting for a long time, growth will fall below potential starting in the third quarter of next year," adding, "We maintain a soft landing view, but there is a risk of recession if growth weakens."
In contrast, Goldman Sachs believes the Fed will keep rates at a high level longer than expected. Economist David Mericle projected in a report released the previous day that the Fed would begin cutting rates by 0.25 percentage points in the fourth quarter of next year. After that, the Fed would cut rates once per quarter through mid-2026, totaling a 175 basis point reduction. Under this scenario, the interest rate by mid-2026 would be between 3.5% and 3.75%.
Mericle explained, "Our forecast can be seen as a compromise between Fed officials who believe there is no need to keep rates high once inflation is resolved and those who think there is no need to stimulate an already strong economy with rate cuts." Goldman Sachs’s forecast for real GDP growth at the end of 2025 is 1.9%, exceeding those of UBS (1.7%), Morgan Stanley (1.4%), and even the Fed (1.8%). The unemployment rate is projected at 3.6%, the lowest among the four scenarios.
Bloomberg News reported, "Wall Street is divided over how aggressive the Fed’s rate cuts will be," noting that "Morgan Stanley and UBS expect large cuts, while Goldman Sachs does not. Goldman Sachs’s forecast is similar to the Fed’s." According to the Fed’s dot plot released after the September Federal Open Market Committee (FOMC) meeting, the median interest rate is projected at 5.1% at the end of 2024 and 3.9% at the end of 2025. The Fed is expected to update its rate outlook with a new dot plot at the final FOMC meeting of the year in December.
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