Synopsis:

Morgan Stanley warns that the Fed is unlikely to respond quickly enough to prevent a recession sparked by tariffs and other structural challenges. Timing issues, conflicting mandates, and the underappreciated impact of immigration restrictions could constrain the Fed’s ability—and willingness—to ease policy aggressively.

Key Points:

• Tariffs' delayed impact: Inflation rises first (within months), while growth weakens later (over quarters), putting the Fed in a bind.

• Fed’s dual mandate dilemma: The Fed must see growth as the primary problem—not just one of many—to justify cutting rates meaningfully.

• Labor force restrictions: Ongoing immigration limits are reducing labor supply growth, lowering the economy’s potential growth rate.

• Inflation mandate takes priority: A smaller labor pool means unemployment won’t rise sharply in a slowdown, making inflation the more urgent concern for the Fed.

• Policy implications: The Fed may tolerate slower growth to keep inflation in check, rather than stepping in quickly with rate cuts.

Conclusion:

Investors hoping for an aggressive Fed response to a potential recession may be disappointed. With inflation risks lingering and structural labor shortages constraining economic capacity, the Fed could remain on hold longer than markets expect—even in the face of slowing growth.