Investing.com – The near-term risk for equity markets revolves around weak jobs data and whether investors feel the Federal Reserve’s response is fast enough, according to analysts at Morgan Stanley.
In a note to clients on Monday, the bank highlighted signs of a softening American labor market, which investors are now wagering could lead the Fed to slash interest rates later this week.
Still, while traders’ expectations for impending and deep reductions in borrowing costs have grown, it remains to be seen if the Fed — wary of lingering inflationary pressures — will be in agreement with the market’s call for a “need for speed” in bringing down rates, the analysts said.
This tension could lead to “some consolidation” in equity indices during a traditionally “weak seasonal period” over the next six-to-eight weeks, they flagged.
However, the analysts said they were “buyers of dips” into the end of 2025, and “continue to lean” towards their bull case for the S&P 500 reaching a level of 7,200 by the middle of next year. On Friday, the benchmark index closed at 6,584.29.
This view is driven by “better and broader than expected” earnings growth, they said, adding that possible weakness in government hiring this autumn could push the Fed to be “even more dovish than the bond market is pricing.” Ultimately, such a scenario would be “positive for stocks,” the analysts said.
The Morgan Stanley analysts recently backed away from a bias towards large-cap names, arguing that a “positive correlation” between inflation breakevens — a measure of expected price growth — and equity returns may bode well for “small caps and reflationary plays” in 2026.
Traders are now all but certain that the central bank will slash interest rates at the end of its latest two-day gathering on Wednesday.
Underpinned by the indications of a weakening U.S. labor market, policymakers are widely anticipated to back the first rate cut since pausing a cycle of drawdowns in December. Lowering rates can, in theory, help spur investment and hiring.
However, a reduction can risk pushing up inflationary pressures at the same time. Last week, a monthly U.S. consumer price index reading accelerated slightly due to an uptick in housing and food costs, a potential indication of sticky inflation.
Yet a separate gauge displaying a rise in weekly initial jobless claims likely kept a Fed rate cut on track. There is now a roughly 95% probability that borrowing costs are lowered by 25 basis points, as well as about a 5% chance of a deeper half-point drawdown, according to CME’s FedWatch Tool. The Fed’s target rate currently stands at a range of 4.25% to 4.5%.