Morgan Stanley: Waller's Rate Hike Path May Fall Below Market Expectations; Balance Sheet Reform Is Key
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Morgan Stanley chief global economist Seth Carpenter argues the Fed's 25 bp September hike is a calibration within the existing framework, not a regime shift; if balance-sheet reform materialises, the ultimate rate peak could sit at the low end of market expectations.
What does the September hike actually signal?
The Fed raised rates by 25 basis points in September — a move markets had fully priced in. Carpenter stresses this is a "degree adjustment", not a fundamental policy pivot.
This means → the Fed is saying "inflation isn't falling fast enough," not switching to an entirely new tightening playbook.
In plain terms = they pressed the accelerator on the same road, rather than turning onto a different one.
Why do Warsh's public views clash with his press-conference stance?
Fed Chair Kevin Warsh has publicly argued that above-target inflation stems from the size of the Fed's balance sheet — the total bonds the Fed holds — rather than the interest-rate level itself.
Yet at the September press conference he barely mentioned this view, leaning instead on the conventional rate tool — a visible tension between words and actions.
This reflects a reality: Warsh's balance-sheet thesis has not yet won consensus inside the FOMC, so he still needs the "standard weapon" of rate hikes to maintain credibility.
How should investors read the dot plot?
The current dot plot — the chart mapping each FOMC member's rate forecast — shows a median of just one more hike, with an option for a second.
Carpenter cautions that the dot plot signals direction, not a precise schedule: "If inflation doesn't improve, we're willing to tighten further."
Next year's voting-member rotation could shift actual hiking appetite away from what the current dots suggest.
Is inflation actually falling or not?
The six-month inflation trend indicator Warsh has repeatedly cited is declining, but not fast enough to reach the Fed's comfort zone.
Meanwhile, energy prices are rising again on supply disruptions and a rebound in risk premia — adding upside risk to the inflation path.
This means → the broad direction is right, but the pace is too slow — and that gap is exactly why the Fed chose to hike rather than hold in September.
Why is balance-sheet reform the real variable to watch?
Morgan Stanley expects that once Warsh's internal working groups finish their review, a balance-sheet reform plan — shrinking the Fed's bond holdings to tighten financial conditions — could be implemented.
In plain terms = if shrinking the balance sheet can do similar tightening work to rate hikes, the Fed won't need to push rates as high.
The bank's base case: this hiking cycle is closer to "unwinding last year's insurance cuts" than launching a new systemic tightening campaign. If inflation eases as expected, the final policy rate will land at the low end of market pricing.
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