Investing.com -- Morgan Stanley expects the Federal Reserve to hold interest rates through the rest of 2026 before beginning a gradual easing cycle in 2027, with the bank's mid-year outlook resting on fading tariff passthrough and limited spillover from higher oil prices into core inflation.

Analyst Michael Gapen said the Consumer Price Index data was broadly consistent with those assumptions.

Tariff pressures decelerated in April, with goods more exposed to tariffs rising less than in prior months, while Morgan Stanley estimates tariffs have lifted the price level by roughly 64 basis points so far, close to the approximately 70 basis points its models imply as a total.

The bank expects core goods inflation to normalize as the tariff impulse fades.

On energy, higher oil prices pushed gasoline higher for a second consecutive month, keeping headline inflation elevated, but Morgan Stanley mentioned that spillovers into core components remain narrow, with airfares the only category showing clear acceleration.

“We expect US growth to remain close to trend, with real GDP expanding 2.3% in 2026 and 2.6% in 2027. A modest drag from higher energy prices caps real consumption growth at 1.8% in 2026, with disproportionate pressure on lower‑ and middle‑income households,” Gapen wrote.

Business investment is expected to provide a meaningful offset, with AI-driven capital expenditure lifting nonresidential investment growth to 7% to 8% and hyperscaler spending exceeding $1 trillion by 2027.

Morgan Stanley described the labor market as maintaining a "curious balance," with monthly payroll gains of 50,000 to 60,000 sufficient to keep unemployment drifting toward 4.1% by 2027.

The bank forecasts core PCE easing to 2.8% to 2.9% in 2026 and 2.3% in 2027, with the terminal fed funds rate settling at 3.0% to 3.25%.