After a rollercoaster year for markets and a challenging economic landscape, Morgan Stanley has released its much-anticipated mid-year economic forecast, painting a sobering picture for the remainder of 2025 and beyond, as reported by Morgan Stanley in its Midyear Global Outlook: Skewing to the Downside, released May 21, 2025.
The forecast comes amid increasing concerns about stagflation and recession, after back-to-back years of robust S&P 500 performance.
Market volatility sets the stage
The economic backdrop for Morgan Stanley’s updated outlook has been tumultuous. After hitting an all-time high in mid-February, the S&P 500 plummeted nearly 19% on concerns about a slowing economy and renewed inflation fears, partly driven by tariff debates, as reported by Morgan Stanley.
Though a relief rally has since erased much of those losses, the seismic market movements have rattled investor confidence.
Meanwhile, Jerome Powell and the Federal Reserve find themselves in an increasingly difficult position, balancing their dual mandate of low inflation and unemployment in an environment where these goals appear increasingly at odds.
Growth projections cut dramatically
Morgan Stanley’s Chief U.S. Economist, Michael Gapen, has revised the firm’s economic projections downward.
The forecast now calls for anemic real GDP growth of just 1% in both 2025 and 2026 (measured quarterly, year-over-year), significantly below the 3% growth seen last summer, as reported by Morgan Stanley. This projection follows an already concerning 0.3% GDP contraction in the first quarter of 2025.
Stubborn inflation expected to persist
Despite earlier progress in taming inflation from its 8% peak in mid-2022, Morgan Stanley expects inflationary pressures to remain stubborn. The forecast indicates inflation will peak in the third quarter of 2025, finishing 2025 between 3% and 3.5% – still well above the Fed’s 2% target, as reported by Morgan Stanley.
This persistent inflation is partly attributed to tariff policies, including a 30% tariff on Chinese goods, a 25% levy on imports from Canada, Mexico, and autos, and a 10% baseline tariff on other goods. According to Gapen, these measures will result in an effective tariff rate of 13% that will continue to pressure prices throughout the economy.
Job market showing cracks
The employment picture is also deteriorating according to Morgan Stanley’s analysis. While the current unemployment rate of 4.2% remains historically low, it’s a significant increase from 3.4% in 2023. The firm projects unemployment will continue rising gradually, reaching 4.8% by the end of 2026, as reported by Morgan Stanley.
This projection aligns with recent labor market indicators showing fewer job openings, increased layoffs, and deteriorating consumer sentiment. The University of Michigan’s Consumer Confidence Survey has fallen sharply to 50.8, down 27% from a year ago.
Rate cuts pushed into 2026
Perhaps the most significant revision in Morgan Stanley’s forecast involves interest rates. Contrary to earlier market expectations of rate cuts this year, Gapen now believes the Federal Reserve will delay additional interest rate cuts “into 2026,” as reported by Morgan Stanley.
The Fed faces a precarious position: cutting rates risks fueling inflation, while raising them could push the economy into recession. This dilemma has apparently convinced Morgan Stanley that Powell will opt for a cautious approach, maintaining higher rates for longer than previously expected.
However, Morgan Stanley does anticipate that by 2026, weakening economic conditions will force the Fed’s hand. Gapen projects that the Federal Funds Rate will eventually fall to a target range of 2.5%–2.75% by the end of 2026 – a significant reduction from the current 4.25%–4.5% range, but one that will arrive much later than previously anticipated.
Widening deficit complicates the picture
Adding to the challenging outlook, Morgan Stanley projects a worsening U.S. deficit situation. The forecast calls for the deficit to climb to 7.1% of GDP from 6.3% in 2025, representing “an increase of $310 billion year on year,” as reported by Morgan Stanley.
This fiscal deterioration adds another layer of complexity to an already challenging economic environment, potentially limiting policy options if economic conditions worsen further.
Walking an economic tightrope
While Morgan Stanley stops short of predicting an outright recession, its forecast presents a concerning economic scenario: stagnant growth, persistent inflation, rising unemployment, and delayed rate cuts, as reported by Morgan Stanley. The firm is projecting a period of extended economic malaise rather than a sharp downturn.
For investors, consumers, and policymakers, navigating this uncertain terrain will require careful planning, realistic expectations, and perhaps a greater tolerance for continued market volatility as the economy works through these significant headwinds.
Add a Comment