Powell’s Path: Rate cuts and economic outlook after Jackson Hole Summit

The Jackson Hole Summit concluded, highlighting Fed Chair Powell’s speech on Friday, in which he explicitly laid out the path for a September rate cut. The cut would be the first policy change since July 2023, when the Fed raised rates by 25 basis points to a high target of 5.50%, and would be the first rate cut since March 2020, when the Fed cut rates to a Covid-cycle low of 0.25%.

The Fed began raising interest rates after two years in March 2022 with a 25 basis point increase to 0.50%. Eleven separate policy changes from the low level raised the target to 5.5% over the next sixteen months (reached in July 2023).

The September 18 meeting is almost over with the rate cut, but the question remains whether it will be a 50bp or 25bp cut. The odds of a 50bp cut have risen to 35% from 26% on Friday before the chairman’s comments. Next week’s US jobs report (September 6) will be a key release.

So, in review, what are some of the key quotes and implications included in President Powell’s speech:

Policy prospects:

• “The time has come to adjust policy. The direction is clear, and the timing and pace of rate cuts will depend on incoming data, changing expectations, and the balance of risks.”
• Conclusion: The US Federal Reserve appears ready to adjust its policy stance, including potential interest rate cuts, but the details will depend on future economic data and the overall risk landscape.

Powell said about inflation:

• “Inflation is now very close to our target, with prices rising by 2.5% over the past 12 months. After a pause earlier this year, progress towards our 2% target has resumed.”
• Conclusion: The Fed has made significant progress in bringing inflation down to its 2% target, demonstrating the effectiveness of its restrictive monetary policy. Now it’s time to take the foot off the brakes.

Regarding the labor market, Powell said:

• “Today, the labor market has cooled significantly from its previously overheated state… Overall, labor market conditions are now less tight than they were before the pandemic in 2019—a year in which inflation fell below 2%… We will do our utmost to support a strong labor market while making further progress toward price stability.”
• Conclusion: The labor market is less tight than it was before the pandemic and is no longer a major source of inflationary pressure, suggesting that the Fed has succeeded in striking a balance. The labor market is also more balanced, and with it the demand for higher wages has declined.

On the balance of risks between inflation and the labor market:

• “Upside risks to inflation have diminished. Downside risks to employment have increased. As we highlighted in our recent FOMC statement, we are paying close attention to risks to both sides of our dual mandate.”
• Conclusion: The Fed is now keeping a close eye on both inflation and employment risks, recognizing that the labor market now faces greater downside risks despite easing inflationary pressures. Unemployment can breed unemployment. The Fed doesn’t want to turn the labor market upside down as every company announces plans to cut jobs.

On the Federal Reserve’s success in reducing inflation rates:

• “The four-and-a-half-point decline in inflation from its peak two years ago has occurred in the context of falling unemployment rates – a welcome and historically unusual outcome.”
• Conclusion: The Fed has succeeded in bringing inflation down significantly without causing unemployment to rise sharply, a rare and positive outcome attributed to well-established inflation expectations.

About future considerations:

• “Our statement on long-term objectives and monetary policy strategy underscores our commitment to review our principles and make appropriate adjustments through a comprehensive general review every five years.”
• Conclusion: The Fed remains committed to continually reviewing and adjusting its policy framework, demonstrating openness to new ideas, and focusing on learning from the unique challenges posed by the pandemic.

In addition to the Fed chairman, other Fed officials commented Thursday and Friday ahead of the president’s remarks:

• On Thursday, Federal Reserve Board member Patrick Harker kicked off the Fed’s policy from Jackson Hole, highlighting that while the labor market is softening, it is doing so from a very high level, and that recent labor market revisions were not unexpected. He stressed the importance of balancing the risks between inflation and other economic factors, and moving away from a singular focus on inflation. Harker expressed his preference for a gradual, methodical approach to price cuts, noting that companies are more interested in a predictable, steady path to neutral prices than the exact size of the cuts.He acknowledged that the current situation Monetary policy is in good shape and not overly restrictive.Harker also noted that The end of the easing cycle could leave the federal funds rate at around 3%.Harker expects unemployment to rise below 5% and continues to watch the commercial real estate sector closely. Overall, Harker appears ready to start cutting rates, preferring a cautious and deliberate approach.

• On Friday, Fed member Raphael Boucek was a bit dismissive, saying more data was needed. However, he expressed optimism about the progress made on inflation, noting that it has fallen much faster than he expected. He added that the faster-than-expected improvement suggests that the Fed may be approaching a point where it would be appropriate to start cutting interest rates. Boucek, however, stressed the importance of Monitor upcoming labor market data carefully before making any final decisions.He stressed the need for a “calm and orderly return to normalization” in monetary policy, highlighting that while recent economic data has been positive, patience is still necessary. Posetic acknowledged that markets are eager for the Fed to conclude its tightening cycle, but reiterated that future actions will be guided by incoming data, with possible outcomes ranging from no rate cut to a 50 basis point cut. He also estimated the Fed’s long-term target rate at around 3%, signaling a cautiously optimistic outlook for the economy.

• Chicago Fed President Austin Goolsbee stressed the importance of balancing the Fed’s dual mandate, particularly on employment. He highlighted that while inflation is on track to hit its 2% target, the Fed’s current monetary policy is the most hawkish this cycle, despite a pause in rate hikes last July. Goolsbee noted that the labor market has shown signs of slowing, but stressed that there is uncertainty about the precise level of the neutral interest rate. He also noted that the Fed’s outlook indicates broad support for rate cuts, with most committee members expecting multiple cuts through 2024 and 2025. However, the speed and size of these cuts will depend on incoming economic data. Goolsbee stressed that the overall path of rate cuts is more important than the size of individual cuts, and while there are concerns about consumer strength, recent spending data has been strong.

ECB Governor Rehn also made some comments on the sidelines of Jackson Hole saying the ECB was likely on track for further cuts, saying:

• The European growth outlook appears weaker than that of the US. Rehn highlighted that the ongoing deflationary process, which began in the fall of 2022, is ongoing and supports the case for a possible rate cut in September. Despite the general downward trend in inflation, strong inflation in the services sector remains a concern. Rehn stressed that the ECB already has enough data to inform its decision in September, but that it remains open to all options, including a 50 basis point cut, stressing the importance of relying on the data and not committing to any specific action prematurely.

Other news over the weekend from a geopolitical perspective:

• In geopolitical news on Sunday, Israel launched a preemptive airstrike on Hezbollah in southern Lebanon, reportedly using 100 fighter jets to hit 40 sites. The action, according to sources, came after Israel discovered that Hezbollah was preparing a large-scale missile attack on northern and central Israel, with the intended target being Mossad, the Israeli spy agency.

Next week:

The economic calendar is relatively light this week with:

Monday

• German Ifo business climate index came in at 86.0 vs. 87.0 last month. Current conditions estimate at 86.5 vs. 87.1 last month. Expectations at 86.5 vs. 86.9 last month (4 a.m. ET)
• US Durable Goods Orders for July. Estimated 5.0% vs. -6.7% last month. Durable Goods Excluding Transportation 1 is 0.1% vs. 0.4% last month. Non-Defense Capital Goods Excluding Aerospace 0.0% vs. 0.9% last month (8:30 a.m. ET)
• Dallas Fed Manufacturing Business Index for August. Last month -17.5 (10:30 a.m. ET)

Tuesday:

• US Consumer Confidence 10am ET

Wednesday:

Australia CPI estimates 3.4% YoY vs. 3.8% last month (to be released Tuesday in the US at 9:30pm ET)

Thursday:

• German CPI Preliminary Reading 0.0% vs. 0.3% Expected (8 a.m. ET)
• U.S. Q3 Preliminary GDP: 2.8% vs. 2.8% advance (8:30 a.m. ET)
• US Initial Jobless Claims Estimated 234K vs. 232K Last Week (8:30 AM ET)

Friday:

• EU CPI YoY Estimated 2.2% vs. 2.6% last month (5 a.m. ET)
• Canada GDP MoM Estimates 0.1% vs. 0.2% last month (8:30 a.m. ET)
• The US core CPI was 0.2% on a monthly basis, compared to 0.2% in the previous month.

Nvidia will also highlight U.S. corporate earnings this week on Wednesday after the close. Crowdstrike and Salesforce will also report after the close.