The Fed Calls Time for a Reality Check

The US Federal Reserve cut its benchmark short-term interest rate for the second time this year, but some observers were disappointed the Fed didn’t more strongly signal future easing moves. Franklin Templeton Fixed Income CIO Sonal Desai shares her thoughts on why the central bank needed to rein in expectations a bit.

At its September policy meeting, the US Federal Reserve (Fed) cut its benchmark interest rate by 25 basis points (bps), to a range of 1.75% to 2%,1 validating market expectations.

Chairman Jerome Powell’s message in the press conference following the meeting, however, was more carefully calibrated than in the past—in my view—and it had a sobering effect. While the market’s immediate reaction was disappointment, I believe the Fed needed to rein in market expectations on the future path of rates. This was a reasonable first step.

With two rate cuts under his belt this quarter, Powell said he expects this latest monetary easing to have an impact with the usual long and variable lags; and, he noted that the Fed expects growth to remain solid, the labor market to stay strong and inflation to gradually move up to its target.

The Fed stated it will keep monitoring trade uncertainty and the recent weakening in Europe and China. However, the US outlook remains unchanged, with strong household consumption and a cautious business sector. And while the Fed can’t eliminate trade uncertainty, Powell expressed confidence that the Fed’s moves will support durable goods consumption, the housing sector, and consumer and business confidence.

In other words, the message from the Fed is that there is no reason to panic, we are not on the verge of a recession, and there is no reason to expect massive further monetary easing.

Indeed, Powell sounded unimpressed by yield curve inversions: He noted that US long-term Treasury yields had dropped sharply and then retraced most of the movement within a few days. He stated swings in global demand for US Treasuries and in market sentiment play a key role in the inversion, and the Treasury yield curve does not tell us much about the US economic outlook. Perhaps unsurprisingly, I find myself in agreement with Powell here.