Fed Pivot Becomes Fed Prayer

The US Federal Reserve is turning increasingly hawkish—hiking rates fast enough to slow inflation while maintaining economic growth will be a monumental task. The Franklin Templeton Investment Solutions team opines on what to expect from the Fed and gauges whether it is already behind the curve.

Since we published “The Fed: Walking a Tightrope in 2022” in late January, Russia invaded Ukraine and the Federal Reserve (Fed) raised interest rates for the first time since 2018. As the Fed begins another hiking cycle, we provide our updated thoughts. The Fed’s balancing act has become even harder.

Key Points

  • The Fed is behind the curve: There are abundant signs that the economy is overheating, with inflation pressures elevated.
  • The Fed is increasingly more hawkish, but risk of a policy error is high: Elevated inflation in a highly uncertain environment means the Fed has a very narrow policy path to achieve the desired soft landing.
  • Multi-asset investment implications: We have preferred short duration exposure but have become slightly less negative on intermediate- and longer-duration assets due to recent market developments. While we are still favorable on risk assets, such as high yield bonds, bank loans, and equities, we are increasingly more cautious as we look one year out and think about the potential of a Fed policy error. We provide more details below, including our views on other assets such as investment-grade corporates and emerging market debt.

Fed Behind the Curve

The Fed has dual mandates of maximum employment and stable prices. One indicator where these goals intersect is wages, as a very tight labor market would create upward pressure on wages. Today, we see many signs the Fed is behind the curve:

Exhibit 1: US Fed Funds Target Rate vs. Wage Growth

Key facts: