Chair Jerome Powell will usher in the next chapter in the Federal Reserve’s inflation battle on Friday, when he’s expected to set the table for an interest-rate cut while reassuring investors that policymakers can stave off a sharp economic slowdown.
The hotly anticipated speech at the Fed’s annual gathering in Jackson Hole, Wyoming, comes at a high stakes moment for the US central bank and the $27 trillion Treasury market. Powell and his colleagues appear on course to lower borrowing costs just seven weeks before the presidential election, a precarious task that will put the Fed chief and his colleagues under intense public scrutiny. It also comes as officials pay increasing attention to the cooling labor market after years of laser focus on price pressures.
“The question is: Will we have a policy error? That’s why the market’s teetering on edge around the Jackson Hole statement,” said Joseph Brusuelas, chief economist at RSM US LLP. “What we need to hear from the chairman is where the Fed is on the potential policy pivot.”
Investors have been on edge as they try to anticipate the pace and size of the cuts ahead. July’s labor-market figures set off a serious bout of market volatility in early August, when the S&P 500 Index of US stocks lost more than 6% in three trading days. Treasuries rallied and, for several days, traders predicted the Fed would launch rate cuts in September with a larger-than-usual move of 50 basis points.
Powell and fellow policymakers have mistepped before. They have deftly guided inflation back toward their 2% target, but that came after they failed to move quickly enough to stem rising inflation during the pandemic. Fed officials are now determined to avoid a similar wreck on the employment front just as price pressures cool.
But cracks have appeared in what had been a surprisingly, and historically, strong jobs market.
Last month, US employers slowed their pace of hiring, while the unemployment rate ticked up for the fourth consecutive time, stoking concerns that high interest rates are dragging the labor market closer to a tipping point. Several economists are also expecting the government Wednesday to make a significant downward revision of employment reports in the year through March.
A key question for those watching Powell, particularly in bond markets, is whether another lackluster jobs report would open the door to a jumbo-sized cut next month, or force the Fed to take an aggressive approach to cutting rates in the months that follow. The Fed chief will deliver his remarks at 10 a.m. New York time on Friday at the Kansas City Fed’s Economic Policy Symposium.
“There could be an argument for going a little bit faster upfront and then slowing,” said Matthew Luzzetti, chief US economist at Deutsche Bank. “I think that argument really only gains substantial weight if there is evidence that the labor market is weakening in a more meaningful way.”
When Powell spoke a year ago at Jackson Hole, he and his colleagues still seemed headed in the opposite direction. Fed officials had, just a month before, lifted their benchmark rate to a range of 5.25% to 5.5% — the highest level in a generation. Powell described the labor market as tight, called inflation “too high” and said the Fed was “prepared to raise rates further if appropriate.”
Inflation Relief
Relief has since arrived. While inflation remains above the Fed’s 2% goal, it has come down notably. A key measure of underlying price pressures cooled in July for a fourth straight month, confirming the downward trend.
“We expect him to acknowledge that conditions are in place for them to begin dialing back policy soon,” said Pooja Sriram, an economist at Barclays. “It’s not clear whether he’s going to explicitly say September or not, but I think the message would be that they seem well-positioned to do that.”
Powell’s message this year will require careful calibration. The rationale for cuts will have to be strong enough to address the political pressures surrounding the Fed in this election year. That could involve pointing to a slowing jobs market and softening growth. But, said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, he won’t want to send too negative a message on the economic outlook.
“A downward adjustment doesn’t mean that anything is wrong,” she said. “To prevent a negative signal from being sent, the Fed needs to be very clear with its communication.”
Since the market’s spasm in early August, bond traders have trimmed their rate-cut expectations as risk assets have rebounded and recent data — including figures pointing to a continued low level of layoffs and a resilient US consumer — have suggested the economy is not falling off a cliff.
Nervous Markets
Traders are currently pricing in a quarter-point reduction next month and expect a total of 75 to 100 basis points in cuts by the end of the year, down from 100 to 125 on Aug. 2.
When asked about the possibility of a 50 basis point cut in July, prior to the most recent employment figures, Powell said, “I don’t want to be really specific about what we’re going to do, but that’s not something we’re thinking about right now.”
He and other Fed officials have repeatedly emphasized that policy decisions will be guided by the “totality” of incoming data. One additional jobs report and two inflation releases will arrive before the Federal Open Market Committee meets Sept. 17-18.
“Without that information, Powell cannot definitively say in Jackson Hole they will lower rates 50 or 25” basis points, said Lindsay Rosner, head of multi-sector fixed income at Goldman Sachs Asset Management. “He is going to keep that openness available, preserve optionality as he should. That’s his job.”
The symposium’s theme this year is “Reassessing the Effectiveness and Transmission of Monetary Policy,” an apt topic given that many investors and economists are also questioning how fast the pace of rate cuts will be in coming months – and at what level they will end.
The nuances of the economy in the wake of the Covid-19 pandemic have complicated that consideration. Some Fed officials believe the neutral rate — which reflects a policy stance that neither slows nor stimulates the economy — may have moved higher since the pandemic, raising uncertainty about how restrictive the central bank’s policy really is.
“They really don’t know the destination point,” MacroPolicy Perspectives’ Rosner-Warburton said. “I think he will emphasize that uncertainty and point to the guidance from the data. The data will help tell them what that destination is and they can move more slowly or rapidly depending on what the economy is telling them.”
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