Investing.com - Morgan Stanley expects the Federal Reserve to remain on hold through year-end as disinflation continues, driven by completed tariff pass-through, energy price relief, and moderating shelter inflation. The firm forecasts July headline PCE inflation at 0.14% and core PCE at 0.23%.

The firm's disinflation thesis rests on several assumptions. Tariff pass-through is largely complete and core goods inflation will move closer to its pre-Liberation Day trend, though AI-related demand may keep upward pressure on electronics prices. The baseline Middle East conflict scenario assumes WTI crude remains around $80 per barrel, keeping energy-driven price pressures muted.

July CPI data showed core inflation rose 0.22% month-over-month and headline increased 0.07%, putting core CPI at 2.5% year-over-year and headline at 3.3%. Core goods in CPI have been flat on average since January, with three-month and six-month annualized rates at -0.1% and 0.4%, suggesting tariff pass-through has ended.

Morgan Stanley projects core PCE inflation at 3.27% and headline at 3.64% for July. The firm's tracking implies a three-month annualized core PCE pace of 2.79% and six-month pace of 3.30%, down from 2.89% and 3.76% in June.

The firm forecasts the Fed will stay on hold this year and reduce its policy rate by 50 basis points next year, with 25-basis-point cuts in March and June, assuming core PCE inflation slips to 3.0% year-over-year in December and 2.4% at the end of 2027. Risks to the outlook skew toward a firmer policy rate path if supply-side shocks reappear or AI-related demand pressures intensify.