Woofun AI reports that Morgan Stanley chief global economist Seth Carpenter has solidified a baseline forecast of zero Federal Reserve rate hikes for the remainder of the year, directly challenging the prevailing market narrative regarding artificial intelligence. Presented after the ECB's annual gathering in Sintra, Portugal, the new Federal Reserve chair, Jane Walsh, has signaled a policy path that renders near-term tightening improbable. This stance defies the widely held belief that AI-driven productivity gains will inevitably trigger rate cuts, a view Carpenter labels as "almost certainly wrong" based on current economic indicators and policy signals.

The core of this assessment stems from Walsh's address at the Sintra Policy Forum, where her tone echoed the commitment to price stability outlined in her inauguration speech while introducing nuanced shifts in policy framework. Carpenter observed that Walsh moved away from an almost exclusive focus on inflation to a more balanced acknowledgment of her dual mandates, specifically highlighting the goal of full employment alongside price stability.

Furthermore, Walsh explicitly noted that the most recent policy meeting, combined with falling oil prices, had already succeeded in dampening market inflation expectations and term premiums. She also mentioned the formation of several "working groups" to address these issues, a process Carpenter interprets as requiring significant time, thereby making a rate hike by the Federal Reserve in July highly unlikely.

Data compiled by Woofun AI highlights the fundamental economic metrics supporting this patient stance, particularly the recent Non-Farm Payrolls (NFP) release which continues to provide the Federal Reserve with ample room to remain cautious. Morgan Stanley's internal inflation forecasts stand significantly lower than the median estimates held by FOMC members, suggesting a divergence between market anxiety and institutional projections.

Additionally, potential revisions to the PCE inflation methodology could further reduce reported inflation figures, reinforcing Carpenter's comfort with maintaining a no-rate-hike forecast throughout the year. While Carpenter acknowledges that new data could alter the trajectory, current evidence points consistently toward a period of policy inaction rather than tightening.

A more critical variable is the complex relationship between artificial intelligence and monetary policy, where Carpenter dismantles the simplistic assumption that technology will drive deflationary pressures necessitating rate cuts. He argues that the wave of AI-related capital spending, which began earlier and on a larger scale in the United States, could actually exert a marginal upward effect on inflation in the short term. Carpenter posits three structural counterpoints: first, the state of the business cycle remains the primary determinant of policy direction; second, deflationary effects are only one factor, as higher productivity can simultaneously boost demand through increased consumption and investment; third, faster productivity growth implies a higher equilibrium interest rate, known as r, which fundamentally weakens the case for rate cuts. Consequently, the narrative that AI will inevitably lead to lower rates is viewed as economically unsound.

In contrast to the Federal Reserve's measured approach, the European Central Bank (ECB) appears to be on a divergent path with a clearer tilt toward tightening. Carpenter noted that ECB President Christine Lagarde, speaking at Sintra, defended the June rate hike as a well-thought-out strategic decision rather than merely a 'precautionary rate hike.' This characterization suggests to Carpenter that the ECB may have room for further tightening measures.

Despite the potential for further action, Morgan Stanley's baseline forecast predicts the ECB will raise rates by another 25 basis points in September, contingent on specific economic developments.

However, Carpenter warns that soft data introduces significant uncertainty into this outlook, citing weak inflation data in Europe from last week and sharp drops in oil prices. Should inflation continue to weaken or PMI figures in Europe show significant weakness, the momentum for further rate hikes could be hindered, forcing a reassessment of the European policy trajectory.

The persistence of Morgan Stanley's no-rate-hike forecast implies that there is no need for the market to price in the risk of near-term rate hikes.

Walsh's Sintra signal: balancing dual mandates, downplaying the urgency for rate hikes. Carpenter, who attended Walsh’s speech at the Sintra forum, interpreted it as a slightly dovish shift. He pointed out that Walsh previously gave the impression of placing price stability as the top priority, but this time she more clearly incorporated full employment into the policy framework. More importantly, Walsh explicitly stated that the latest policy meeting, along with falling oil prices, had pushed down market inflation expectations and term premiums, and mentioned that several "working groups" were being formed, which would take time. Carpenter believes this combination of statements sends a clear message: the Federal Reserve is not in a hurry to take action in July.

He believes that rate hikes in July or more than one hike this year are currently unimaginable.