Morgan Stanley economist sees Fed pause as prelude to more hikes

Market participants anticipate the Fed will keep rates unchanged at its Wednesday meeting. However, Morgan Stanley's top US economist Michael Gapen believes the central bank's pause will indicate that further rate increases are still to come.

Traders have already factored in a pause and are expecting a rate increase in December. Consequently, the wording of the statement, rather than the actual decision, may influence assets that are sensitive to interest rates, including Bitcoin (BTC).

What Would Make a Fed Hold Sound Hawkish?

In an interview with CNBC, Gapen stated the Fed is likely to leave rates unchanged while indicating that more rate increases remain ahead. He noted the committee would claim it requires time to evaluate underlying economic trends before acting.

Dissenting votes, which are those against the majority decision, provide a key signal. When the Fed paused in July, three officials voted for a hike, and Gapen predicts two will dissent this Wednesday.

According to Gapen, a smaller number of dissents would be interpreted as dovish—indicating less appetite for rate increases—whereas three dissents would be seen as hawkish.

Fed Chair Kevin Warsh has refrained from offering a preview of the decision. Despite that, Gapen believes Warsh, who is known for avoiding forward guidance, is unlikely to state that further hikes are probable.

The central bank increased rates in September, and Warsh has identified October and December as the crucial meetings for future decisions.

Can the Economy Absorb More Hikes as Energy Costs Persist?

Gapen noted that stricter financial conditions since the previous meeting provide policymakers with a justification for a gradual approach. The market's current pricing of additional rate increases is already accomplishing some of the Fed's objectives.

Nevertheless, officials still need to determine whether to confirm that market expectation.

At the same time, the ongoing conflict in the Middle East is exerting pressure on oil and diesel markets. Gapen said he would be astonished if Warsh overlooks potential second-round effects, where higher energy costs spill over into broader price levels.

According to Gapen, the economy can withstand a total of 75 to 100 basis points of rate increases, equivalent to one percentage point. In contrast, six or seven total hikes—which would bring rates back to levels seen in 2023—would represent a different scenario.

Gapen thinks the Fed can raise rates at every other meeting while reviewing incoming data, but the energy market will affect the speed of those moves.