Morgan Stanley: US growth accelerates without clear overheating; Morgan Stanley expects two more Fed rate hikes

Why is US growth accelerating again?

US real GDP grew at an annualized rate of 3.4% quarter on quarter in the third quarter of 2026, up from 2.2% in the second quarter. Business investment and household consumption were the main supports.
Equipment spending grew at an annualized rate of 20.9% quarter on quarter in the third quarter, including 37.3% growth in information processing equipment; spending on data center construction rose 127%. Morgan Stanley links the strength in equipment investment to AI capital spending and a broader investment cycle.
Real personal consumption grew at an annualized rate of 3.8% quarter on quarter for two consecutive quarters, but spending has outpaced income: in September, personal spending rose 0.5% month on month, while income rose only 0.2% and the saving rate fell to 3.8%. The bank believes that sustaining recent consumption growth by continuing to draw down savings is unlikely to last.

Morgan Stanley believes current growth has clear supply-side support: higher output per hour has sustained potential growth as labor force growth slows. Real GDP grew 2.1% over the past four quarters, not far from the bank’s estimate of potential growth.
The labor market also shows no clear signs of overheating. Nonfarm payrolls increased by an average of about 51 thousand jobs a month over the past three months, unemployment held near 4.2%, and wage growth slowed; immigration controls have reduced the number of new jobs needed to keep the labor market in balance.
Inflation remains above target: the core PCE price index rose 3.1% year on year in September. The bank expects fourth-quarter year-on-year core PCE growth to be 3.1% at the end of 2026 and to fall to 2.6% by the end of 2027; factors including second-round effects from the oil price shock will slow the decline.

In its baseline scenario, Morgan Stanley expects the Fed to raise rates by 25 basis points each in December 2026 and March 2027, taking the target range to 4.25%–4.5%. The bank believes the Fed can tighten relatively gradually if supply improvements continue to support growth and disinflation.
Another path would see AI investment spread through complementary business spending or consumption to the broader economy, lifting employment and lowering unemployment. Demand-side price pressures could then impede disinflation, requiring higher nominal and real interest rates; the bank’s scenario analysis says rates could return to 5.25%–5.5%.
The bank considers unemployment an important indicator for distinguishing between the two paths and believes that, if it falls to 4.0% or below, the Fed may worry that excessive demand is overheating the labor market.

Morgan Stanley’s baseline scenario for the US economy includes a persistent oil risk premium. The energy price shock has entered its seventh month, and the bank believes buffers such as higher US exports, weaker Chinese imports and ample inventories are diminishing.
As of 23 October, US commercial crude oil inventories fell by 2 million barrels over the week to 410.6 million barrels; the Strategic Petroleum Reserve stood at about 282.6 million barrels, nearly unchanged but at its lowest level since April 1984.
Computers and peripheral equipment needed for AI-related investment have a high import content. The bank believes this could boost overseas output and import prices more; even if import prices create inflationary pressure, the required rate increases could still be smaller than in a scenario of overheating US domestic demand.