Morgan Stanley warns: If the unemployment rate falls below 4%, the Federal Reserve may be forced to raise interest rates.

Morgan Stanley maintains its baseline forecast that the Federal Reserve will hold interest rates steady this year, but warns the stance could shift toward rate hikes if the unemployment rate falls below 4% or inflation remains persistently high. Analyst Michael Gapen noted in a client report that data since the June FOMC meeting has left the firm "somewhat reassured" about its "no rate hike" baseline: oil prices have declined after the signing of the U.S.-Iran Memorandum of Understanding, and the pass-through effect of tariffs is expected to peak. Morgan Stanley forecasts fourth-quarter headline and core PCE inflation at 3.2% and 3.0% respectively, well below the median expectation of FOMC participants. On the labor market front, the firm projects monthly job gains of 50,000 to 60,000 during the summer, enough to keep the unemployment rate roughly stable. However, Gapen warns that if the unemployment rate drops below 4.0%, the Fed may view the risk of an overheating labor market as sufficient to justify rate hikes; the firm would also reassess its stance if monthly core inflation stays at or above 0.3% or if Middle East conflicts escalate again. At the time of this assessment, Brent crude has fallen to around $72.6, and markets are closely watching upcoming employment and inflation data to calibrate policy expectations for the Fed under Chair Powell.