The Fed's last rate hike will come in January, but stocks will still be under pressure from dismal earnings in 2023, Morgan Stanley strategist says

• The Fed could stop hiking rates as soon as January of next year, according to Morgan Stanley's Andrew Sheets.
• Sheets pointed to evidence of falling inflation, though he noted central bankers would likely keep monitoring the economy after pausing rate hikes.
• But while investors are hoping a pause could spark a new rally, stocks will still be under pressure next year on poor earnings, he warned.

The Federal Reserve's last rate hike could come as soon as January, but stocks will still be under pressure from dismal earnings into 2023, according to Morgan Stanley strategist Andrew Sheets.

"We are in the camp that the Fed will be early to pause. We think the last Fed hike is in January," Sheets said in an interview on Bloomberg TV on Wednesday.

Fed officials have warned the central bank needs to make more progress on inflation, which remains well above the Fed's 2% target, before letting up on rate hikes.

But inflation is showing clear signs of coming down, potentially causing the Fed to pause its monetary tightening regime earlier than expected, Sheets said. Prices clocked in at 7.7% in October, down from the 41-year-high of 9.1% in June.

After its last rate hike in January, the Fed will likely hold its policy rate and continue monitoring the economy to see the full effect of its tightening so far, he predicted, adding that there is still a lot of uncertainty on inflation's trajectory next year.

But central bankers risk undoing the tightening they've done so far by pausing rate hikes, Sheets pointed out.

"Can the Fed really pause without reversing the progress that it's made in tightening financial conditions? Almost by definition, once it stops hiking, it's easing. And does that work against everything the Fed is trying to achieve?" he said. "How does it message that, I think is a really big debate."

Stocks are still likely to face downward pressure with dismal earnings into 2023, Sheets said. He pointed to estimates from Morgan Stanley's top stock strategist Mike Wilson, who warned that earnings were 20% too high at current levels, which could cause stocks to plunge to a new bottom early next year.