On My Mind: The Fed Fights Inflation, the Markets Fight the Fed

Markets want to believe policy interest rates will soon fall—but inflation and growth data tell a very different story, argues Franklin Templeton Fixed Income CIO Sonal Desai.

Remember the adage, “Don’t fight the Fed?” It was a key tenet of financial markets’ folk wisdom for so long, passed on from the more experienced traders to the younger ones; a mantra repeated in countless media interviews. If the Federal Reserve (Fed) signaled it would do one thing and you bet against it, the wisdom was, you would lose money.

It now seems as though that wisdom no longer applies. It was unquestionable when the Fed signaled a commitment to loose monetary policy. But now that the central bank signals an intention to keep policy tight for quite a while, most investors are quite happy to bet against it. Markets are currently pricing in significant interest rate cuts—more than one percentage point between now and January of next year. US Treasuries have again rallied even in response to an April Consumer Price Index (CPI) inflation report that shows headline and core measures broadly stable at about 5% and 5.5% respectively (4.9% on the headline, to be precise).

Throughout this tightening cycle, markets have more often than not been fighting the Fed, whether by forecasting a lower peak rate, an earlier pivot to loose policy, or deep rate cuts. Are the markets right?