Morgan Stanley: Fed hold steepens Treasury curve; Morgan Stanley expects fewer hikes than markets price in

Why did the hold steepen the Treasury curve?

The Fed voted 10 to 2 to keep its policy rate at 3.75%–4.00%; two officials favored a 25-basis-point hike. The post-meeting statement upgraded its description of economic growth from “solid” to “strong.”
Chair Warsh repeatedly said financial conditions had tightened, but did not describe them as restrictive. Morgan Stanley said markets interpreted the rate hold as slightly dovish: on 28 October, the two-year Treasury yield fell 3.9 basis points and the 30-year yield rose 3.3 basis points, steepening the yield curve.
The Fed also adjusted its meeting schedule: one of its eight meetings in 2027 will have no rate vote or policy statement, rising to two in 2028. The bank believes less frequent rate decisions increase uncertainty about future policy adjustments and also put pressure on the curve to steepen.

Although the meeting was interpreted as slightly dovish, markets still price in a probability of more than 90% of a hike in December, with roughly 23 basis points of tightening implied for the next meeting.
Morgan Stanley expects two more hikes thereafter, fewer than the approximately 2.8 priced in by markets. The bank believes Warsh’s comments on tighter financial conditions and emphasis on productivity-driven growth imply less need for aggressive policy tightening.
Growth and inflation remain the other side of the policy trade-off: the bank expects US GDP to grow at an annualized quarter-on-quarter rate of 3.1% in the third quarter, up from 2.2% in the second; it expects core PCE prices to rise 0.33% month on month in September, up from 0.2% in August.

Morgan Stanley expects private final domestic purchases to grow by about 4.5% in the third quarter, including consumption growth of 3.7% and nonresidential fixed investment growth of 10.2%, driven by AI investment. All figures are annualized quarter-on-quarter rates.
The bank estimates that inventory changes contributed 1.7 percentage points to third-quarter GDP growth and believes businesses were stocking up for strong demand; meanwhile, AI-related investment drove imports, which it estimates subtracted about 2 percentage points from growth.
But spending momentum is not accelerating across the board: the bank expects real personal spending to grow 0.1% month on month in September, down from 0.6% in August; real disposable personal income is expected to fall 0.2% month on month as overall prices rise.

The Bank of Canada raised rates by 25 basis points to 2.5%. Governor Macklem said the current rate level was still not restraining growth and that there was no predetermined path for future rates.
The Reserve Bank of New Zealand unexpectedly held its policy rate at 2.75% by a 4–3 vote, although markets had widely expected a hike; the governor also said further hikes were highly likely at the next few meetings. The New Zealand dollar fell 1.0% against the US dollar on the day.
Australia’s third-quarter trimmed mean inflation was 3.7%, above the Reserve Bank of Australia’s forecast; markets subsequently priced in a roughly 85% probability of a hike at the following week’s meeting, and the Australian dollar rose 0.4% against the US dollar.