Morgan Stanley IM: The Fed’s Dilemma Is the Market’s Gain

• Sometimes you want to embrace conflict in the market, and this may be one of those times.
  
• The tension points seem to be weakness in the labor market versus higher inflation.
• The issue is that the two are not supposed to co-exist, creating a dilemma for the Fed.
  
• If labor markets are weak, then wage inflation tends to fall, with consumer and goods prices soon to follow.
• The Fed has a framework that forms the basis of their policy reaction function called the Phillips Curve, which solves this dilemma for them.
  
• Despite above target inflation and stronger growth expectations in 2026, the Phillips Curve creates a path for the Fed to cut rates, because it will tilt its dual mandate to focus on the risk of labor market weakness.
  
• In summary, embrace the conflict, because it can support market gains. Why? Let’s get into it!
  

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