This Wall Street expert believes the Fed has ‘more room to cut’ than most people expect in 2026

A nice surprise in US labor market data may be the gift that keeps on giving next year.

Michael Wilson, chief investment officer and chief US equity strategist at Morgan Stanley, when he asked why the market was behaving the way it did – the S&P 500 had a strong year by all accounts – came up with a possible answer: April marked the end of a rolling recession and the beginning of a new bull market, and the Fed was still playing catch-up.

The Federal Open Market Committee is expected to cut interest rates by a quarter of a percentage point this week, according to CME Group and forecast market data. What the central bank will do next remains an open question, but Morgan Stanley believes the labor market woes — private market data show US employers cut 9,000 jobs in November, the fifth month of negative data in the past seven months — could prompt the Fed to cut interest rates further next year as it seeks to correct a delayed reaction of lagging sectors of the US economy resulting from a lack of labor data, boosting US stocks.

Investors can find confirmation that a new bull market began in April in earnings for S&P 500 components, which are now growing nearly 10%, the best in four years, according to Wilson. “This is very important for next year, because it means the Fed has more room to cut than people probably think,” he said in an interview with The Sun newspaper. CNBC Tuesday.

The private sector is witnessing a continuing recession after Covid-19, with each sector going through its own recession instead of a comprehensive collapse, according to Wilson. Although the real-time data did not give the Fed a reason to cut rates, a review of the data could help the US central bank realize that parts of the US economy need it to emerge from the so-called K-shaped recovery.

“I don’t know how much they will cut next year, but they are unlikely to raise interest rates and will likely add liquidity to the balance sheet at a time when accelerating inflation is leading to better earnings growth,” Wilson said. “That’s usually a pretty good setup for stocks.”

Chicago Mercantile Exchange data puts the highest odds for at least two additional cuts by December 2026, assuming what happens this week is within reach. Wilson said more dovish policy “than the market currently expects” could be forthcoming. Morgan Stanley’s price target for the S&P 500 is 7,800 by the end of 2026, roughly 14% above current levels. Wilson is optimistic about lagging sectors this year, including health care and manufacturing.

The risk in the bank’s forecast is that inflation reaches a point that forces the Fed to respond in a different way, according to Wilson. “The question is at what point [does the Fed] “They feel like they then have to raise interest rates that much,” he said. “That will kill the bull market.”