Investing.com -- The conflict involving Iran and the resulting oil price volatility is reshaping expectations for U.S. monetary policy, with Morgan Stanley arguing that the risk distribution now tilts toward delayed, and potentially deeper, Federal Reserve rate cuts.

According to Morgan Stanley’s chief U.S. economist Michael Gapen, “the distribution of monetary policy outcomes is asymmetric.”

Gapen states that the Fed is “more likely to cut later, or to cut later and by more, rather than abandon its easing altogether.”

Morgan Stanley’s base case still expects two rate cuts in 2026, in June and September, assuming the Fed “looks through oil-induced price pressures to deliver earlier-than-expected easing.” But the firm emphasises two key risks.

The first is that higher inflation and still-low unemployment push policymakers to wait.

“Inflation is already at 3.0% and has firmed… rising oil prices could push it further away from target.” In that case, cuts might shift to September and December or even December and March, but still land at the same terminal range of 3.0%–3.25%.

The second risk is more consequential. If the Fed delays too long, tighter conditions could weigh more sharply on activity.

Morgan Stanley warns that “higher-for-longer oil combined with heightened uncertainty does more damage to demand than we expect.”

Under that scenario, the Fed could end up cutting three times, lowering the terminal rate to 2.75%–3.0%.

For now, Morgan Stanley says it is maintaining its baseline view but sees clear risks that the Fed “cuts later than we expect, or cuts later and to a lower trough.”