Fed Rate Hike Is Unlikely, But Risks Loom

May 8, 2024

The Fed’s assurance that a rate hike is unlikely has calmed investors, but are they overlooking mixed economic signals? Here’s what to watch.

Lisa Shalett

Key Takeaways

  • The Fed’s recent dovish guidance may be lulling investors into complacency, but the labor market and growth data send mixed signals.
  • Unemployment is historically low, but a deep drop in posted job openings suggests cracks may be emerging in the labor market.
  • Economic growth data is also mixed, with a pullback in global manufacturing but solid trends in goods orders and capex.
  • Investors should monitor consumer and labor-market metrics and remain focused on portfolio diversification. 

U.S. Federal Reserve Chair Jerome Powell has, once again, appeased investors. Following the latest Federal Open Market Committee meeting, Powell indicated that while interest-rate cuts may be delayed amid stubborn inflation, it is unlikely that the central bank’s next move is a rate hike. That, combined with a slowdown in the pace at which the Fed is shrinking its balance sheet, helped reassure investors that financial conditions aren’t likely to tighten further in the near future.


The stock market has since recouped some of its April losses. However, Morgan Stanley’s Global Investment Committee is not convinced that the coast is clear. To the contrary, we are increasingly concerned that investors may be lulled into a false sense of security by the Fed’s guidance and may overlook mixed signals coming from two key areas of the economy.

Labor Market: Heating Up or Cooling Down?

In some ways, the job market still looks robust. The unemployment rate is a historically low 3.9%, and unemployment claims have remained consistently below the long-term average. Monthly job creation has been solid, even including the lower-than-expected April data, and the Employment Cost Index, a measure of what employers are paying in compensation, is annualizing at 4.8%, well above its pre-pandemic pace. Hiring intentions among large companies have improved, and consumer confidence metrics suggest that workers still think jobs are easy to get.


At the same time, there may be cracks emerging in the labor market. A recent Job Openings and Labor Turnover Survey revealed that job openings fell to their lowest level in three years, while quit rates have normalized, suggesting that employee bravado is fading. In addition, small-business hiring intentions have turned grim against the prospect of higher-for-longer interest rates.

A Muddled Message on Growth

Data related to economic growth is equally messy. The 2024 rebound in global manufacturing now looks less impressive than it did in the first quarter. The S&P Global U.S. manufacturing purchasing managers’ index (PMI) was at 50 in April, indicating neither expansion nor contraction, and the Institute for Supply Management (ISM) Manufacturing Index slid back below expansion territory.


On the other hand, we are not seeing the decreases in demand that one might expect from higher-for-longer interest rates. For example, durable goods orders and capital spending trends remain solid. And notably, existing U.S. home prices continue to reaccelerate.

Should We Trust Fed Guidance?

The Global Investment Committee respects the important role that Fed guidance has played in shaping the market’s expectations since the 2007-08 financial crisis. But we increasingly question investors’ reliance on it in a data-dependent and normalizing world, in which central bankers’ forecasting acumen has proven no better than others’.


Keep in mind that the Fed, itself, doesn’t seem to have an explicitly stated framework on inflation or employment, despite its dual mandate to pursue maximum employment and price stability. Similarly, while Powell continues to assert that inflation is a result of supply shortfalls in the economy, we have yet to see him acknowledge the role of monetary or fiscally driven demand.


All this considered, even as Powell was explicit in his latest guidance that the Fed is not contemplating rate hikes, we are wary of central bank overconfidence. Given increasingly mixed data, separating noise from signal is hard, and odds of a policy mistake in either direction are rising.

How to Invest

Investors should keep an eye on consumer and labor-market metrics to determine whether they are heating or cooling, and prepare for markets to churn within a relatively narrow range.


Consider restoring over- or under-weight allocations in your portfolio back to longer-term targets and erring on the side of diversification. With mega-capitalization and large-cap equities likely to outperform small-caps, consider adding international exposure, staying neutral-to-underweight on longer-duration bonds, and using real assets and hedge funds to help mitigate emerging risks.


This article is based on Lisa Shalett’s Global Investment Committee Weekly report from May 6, 2024, “Delayed but Not Denied?” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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