After closely observing Walsh, Morgan Stanley's chief economist insists: The Federal Reserve will not raise interest rates this year.

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The policy stance of the Federal Reserve’s new chair, Walsh, is under close scrutiny by the markets. Seth Carpenter, Morgan Stanley’s Chief Global Economist, wrote after attending the ECB’s annual conference in Sintra, Portugal, that based on employment data, inflation forecasts, and policy signals, the Fed will not raise rates this year.

In his report, Carpenter wrote that Walsh’s remarks at the Sintra policy forum continued the tone set at his inaugural press conference—he made a strong commitment to price stability but deliberately avoided specifying the pathway to achieve this goal. Carpenter noted two noteworthy changes:

First, Walsh’s statement about the dual mandate is more balanced, shifting from an almost singular focus on inflation to more explicitly acknowledging the goal of full employment;

Second, Walsh specifically emphasized that the most recent policy meeting (combined with falling oil prices) has lowered market inflation expectations and term premium, which made Carpenter believe the likelihood of a Fed rate hike in July is low.

Against the backdrop of uncertainty about the Fed's policy trajectory, Morgan Stanley maintains its baseline forecast of no rate hikes for the entire year, suggesting the market need not price in near-term rate hike risks.

Walsh’s Sintra Signals: Balancing the Dual Mandate, Downplaying Rate Hike Urgency

Carpenter personally witnessed Walsh’s speech at the Sintra policy forum and interpreted it as a marginal, dovish shift. He pointed out that Walsh had previously given the market the impression that price stability was his overwhelming priority, but this speech more clearly incorporated full employment into the policy framework.

More importantly, Walsh actively highlighted that the policy meeting had led to a decline in market inflation expectations and term premium, and mentioned that multiple “working groups” are being formed and still need time. Carpenter believes this choice of words signals clearly that the Fed is not in a hurry to take action in July.

Data Supports Patience: Inflation Forecasts Below FOMC Median, Nonfarm Payrolls Provide Buffer

On the fundamentals side, Carpenter cited several factors supporting the no-rate-hike forecast. Last week’s nonfarm payroll data continues to provide the Fed room to stay on hold. Meanwhile, Morgan Stanley’s inflation forecast is markedly below the median forecast of FOMC members, and revisions to the PCE inflation methodology may further significantly lower inflation readings.

Carpenter said that these factors combined make him feel "comfortable" sticking to no rate hikes for the year. Of course, the data could change this conclusion, but current evidence points in the same direction.

AI and Productivity: Not Right to Bet on Rate Cuts Simply

Carpenter also discussed AI’s impact on monetary policy and questioned the popular narrative that “AI will bring deflation and drive rate cuts.” He noted that the wave of AI capital expenditure has appeared earlier and at larger scale in the US, and in the short term has a marginal upward effect on inflation.

More importantly, he raised three counterpoints: First, the state of the business cycle will dominate the policy direction; second, deflationary effects are just one of many influences—higher productivity will also drive demand through consumption and investment; third, faster productivity growth means a higher equilibrium rate (what economists call r*), which further weakens the logic for rate cuts. Carpenter bluntly stated that the simple assertion that AI must lead to rate cuts is “almost certainly wrong.”

ECB Policy Divergence: 25bps Hike Possible in September, Soft Data Leaves Uncertainty

In contrast to the Fed, the ECB’s policy direction is more clearly tilted toward tightening. Carpenter pointed out that ECB President Lagarde reiterated in Sintra that June’s rate hike was a well-considered decision, rather than a mere “preemptive hike,” which in his view, means there is still room for further rate hikes.

Morgan Stanley's baseline forecast is that the ECB will raise rates by another 25bps in September. However, Carpenter also noted that last week’s soft European inflation data and the sharp decline in oil prices leave room for policy—if inflation remains weak or the PMI drops significantly, the path for further rate hikes may be blocked. He believes that a rate hike in July or more than one hike this year is difficult to imagine at present.

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