Author:Zhao Ying

The policy stance of the new Federal Reserve Chair, Waller, is under close scrutiny from the market. Seth Carpenter, Chief Global Economist at Morgan Stanley, wrote after attending the European Central Bank's annual meeting in Sintra, Portugal, that considering the comprehensive employment data, inflation forecasts, and policy signals, the Fed will not raise interest rates this year.

Carpenter wrote in his report that Waller's remarks at the Sintra policy forum continued the tone from his inaugural press conference — making a strong commitment to price stability but deliberately avoiding the specific path to achieve this goal. Carpenter noted two significant changes worth mentioning:

First, Waller has balanced the expression of the dual mandate, shifting from nearly solely focusing on inflation to more clearly acknowledging the full employment goal;

Second, Waller specifically emphasized that the recent policy meeting (coupled with falling oil prices) has lowered market inflation expectations and term premiums, leading Carpenter to believe that the possibility of a rate hike by the Fed in July is low.

In the context of uncertainty surrounding the Fed's policy path, Morgan Stanley's maintenance of the full-year no rate hike forecast means that the market does not need to price in the risk of a rate hike in the near term.

Waller's Sintra Signal: Balancing the Dual Mandate, Downplaying Rate Hike Urgency

Carpenter personally experienced Waller's speech at the Sintra policy forum and interpreted it as a marginal shift towards being more dovish. He noted that the impression Waller left the market previously was that price stability was the overwhelming priority, whereas this speech more clearly included full employment in the policy framework.

More importantly, Waller proactively pointed out that the policy meeting has driven down market inflation expectations and term premiums, mentioning that several "working groups" are being formed and will take time. Carpenter believes this combination of wording conveys a clear signal: the Fed is not in a hurry to take action in July.

Data Supporting Patience: Inflation Forecasts Below FOMC Median, Non-Farm Employment Provides Buffer

On the fundamental level, Carpenter cited multiple factors supporting the prediction of no rate hikes. Last week's non-farm employment data continues to provide space for the Fed to remain on hold. At the same time, Morgan Stanley's inflation forecasts are notably lower than the median forecasts of FOMC members, and methodological revisions to PCE inflation have the potential for further substantive downward adjustments to inflation readings.

Carpenter stated that, combined, these factors make him feel "comfortable" in his judgment of maintaining no rate hike for the year. Data can certainly change conclusions, but the current evidence points in the same direction.

AI and Productivity: Not to Simply Bet on Rate Cuts

Carpenter also discussed the impact of artificial intelligence on monetary policy, questioning the popular narrative that "AI will lead to deflation and drive rate cuts." He pointed out that the wave of AI capital expenditures emerged earlier and at a larger scale in the United States, having a marginally inflationary effect in the short term.

More importantly, he presented three counterarguments: First, the state of the business cycle will dominate the direction of policy; second, the deflationary effect is just one of many influences, as higher productivity will also drive demand through consumption and investment; third, faster productivity growth means a higher equilibrium interest rate (known as r* by economists), which further weakens the logic for rate cuts. Carpenter bluntly stated that the simple assertion that AI will inevitably lead to rate cuts is "almost certainly wrong."

Diverging ECB Path: Another 25 Basis Points Rate Hike in September Possible, but Soft Data Leaves Uncertainty

In contrast to the Fed, the ECB's policy direction is more clearly tilted towards tightening. Carpenter noted in his article that ECB President Lagarde reiterated in Sintra that the rate hike in June was a well-considered decision, rather than a mere "preventive rate hike," which in his view indicates there is still room for further rate hikes.

Morgan Stanley's baseline forecast is that the ECB will raise rates by another 25 basis points in September. However, Carpenter also pointed out that last week's soft European inflation data and a significant drop in oil prices leave room for policy adjustments — if inflation continues to weaken or if PMI shows significant weakness, the path for a subsequent rate hike may be obstructed. He believes that the ideas of raising rates in July or more than once in the year are currently hard to imagine.