The Fed's last call for the punchbowl?

Perspective from Franklin Templeton Fixed Income

  
The Fed's last call for the punchbowl?
Franklin Templeton

Dr. Sonal Desai, Chief Investment Officer, Franklin Templeton Fixed Income, discusses the Fed’s challenge. With high uncertainty on the inflation and employment outlook, adjusting its exceptionally loose monetary stance at the right time and pace become a very difficult high-wire act.

Investing is tough these days but I’d still rather have my job than the Federal Reserve’s (Fed). The June policy meeting of the Federal Open Market Committee (FOMC) highlighted just how complex the central bank’s challenge is.1 In part it’s because the economic environment has become more complex, but in part it’s the Fed’s own fault.

The Fed’s meeting came off as more hawkish than markets expected: the median Fed funds forecasts (the “dots”) now show two interest-rate hikes in 2023 (compared to none in March); the tone on the growth and employment outlook was more upbeat; the core consumer price index (CPI) forecasts for 2021 and 2022 were raised to 3.0% and 2.1%, respectively.

But what was most striking was 1) a greater degree of humility in acknowledging the uncertainty in an outlook dominated by unprecedented shocks and policy moves; but 2) a still strong reluctance to start adjusting the policy stance.

Assessing the current inflation rebound is hard. The Fed insists it’s temporary, mostly due to base effects, and projects inflation coming down on target by next year. But this time their assessment was a bit more humble. After all, if there is something that can be foreseen is base effects—we do know the past. And yet, the May US inflation number surprised to the upside.

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1 Source: US Federal Reserve. June 15-16, 2021 FOMC meeting.

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All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. 

Bond prices generally move in the opposite direction of interest rates. Investments in lower-rated bonds include higher risk of default and loss of principal. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value. Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.

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