The Federal Reserve’s target for short-term interest rates essentially sets the minimum level of borrowing costs in the United States. On September 18, the Fed reduced its interest rate target for the first time in more than four years. The 0.5 percentage point reduction made the Fed’s new target a range of 4.75–5.00%.
Vanguard’s global chief economist, Joe Davis, and head of fixed income credit, Chris Alwine, explain the meaning of the central bank’s policy shift.
Joe Davis: It felt like a long time coming, right, Chris? We’re talking about a Federal Reserve that's begun an easing process. I think it's, you know, it's welcome news. I mean, we've had, for two years, inflation coming down, really stubborn for a long period of time.
The labor market is still strong, but the unemployment rate's starting to rise a little bit. The rate of job growth has cooled. And so I think what we're seeing is a Federal Reserve that's trying to balance those risks by easing off the level of restriction, which means interest rates are high.
Chris Alwine: Yeah. The fact that the Fed has started in cutting cycle and fairly boldly at 50 basis points, with the explicit goal of stabilizing the labor market. And that's important for the economy to continue to expand. And so I think the fed is on the right track.
The world today is we have inflation and growth around trend. And so the Fed is, is pursuing a path of normalization of policy, which gives them the best chance of extending the economic cycle.
Joe Davis: And our forecast has some turbulence over the next six months, not a recession, but some but some turbulence. Trying to ensure that we have inflation anchored at that 2%, I think what we're saying for investors, listen, this is a good step in the right direction. Because the Federal Reserve is trying to ensure that the expansion continues.
Chris Alwine: Absolutely. And, you know, what are we doing with this? You know, what is our investment strategy here? In the active bond funds, there's really two big drivers---really, three if we think of security selection as well. But it's around what is our duration and yield curve positioning to want to be more price sensitive or less.
And with that, with the Fed starting a rate cycle that were biased to be long duration. And the second is on the credit risk that we take. Are we overweight to corporate bonds, for example?
That puts us in a position that we still like, corporate bonds. So we are overweight to that.
Joe Davis: We'll continue to monitor and, should it change, you'll be the first to let us know.
Chris Alwine: Absolutely.
Joe Davis: And I'll do the same on the economy.
Chris Alwine: Exactly.
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