On Friday, Federal Reserve Chairman Jerome Powell will speak at the Fed's annual Jackson Hole conference, ushering in the next phase of the central bank's fight against inflation, and he is expected to pave the way for rate cuts while reassuring investors that policymakers can avoid a sharp economic slowdown.
The much-anticipated speech comes at a time when the stakes are high for the Fed and the $27 trillion Treasury market. Powell and his colleagues appear set to cut interest rates just seven weeks before the U.S. presidential election, a risky assignment that will expose the Fed chairman and his colleagues to intense public scrutiny. It also comes as officials are increasingly concerned about a cooling labor market after years of focusing on price pressures.
Joseph Brusuelas, chief economist at RSM US LLP, said:
“The question is, will we make a policy mistake? That’s why the market is oscillating around Jackson Hole, and what we need to hear from Powell is the Fed’s stance on a potential policy shift.”
Investors have been on edge as they try to predict the pace and magnitude of future rate cuts. July labor market data sparked severe market volatility in early August, when the S&P 500 fell more than 6% in three trading days. U.S. Treasuries rallied, and traders predicted for several days that the Federal Reserve would start cutting interest rates in September and cut them by 50 basis points.
The Fed's case for a September rate cut must be strong enough
Powell and his colleagues have made mistakes before. Their failure to act quickly enough to stem rising inflation during the pandemic has left Fed officials now determined to avoid a similar disaster on the job front just as price pressures are falling. But cracks appear to be showing in what has been an unexpectedly strong and historically strong job market.
U.S. employers slowed hiring last month and the unemployment rate rose for a fourth straight month, raising concerns that high interest rates are starting to show cracks in the labor market. Several economists also expect the government on Wednesday to make a sharp downward revision to employment data for the year ending in March.
A key question for those watching Powell's speech, especially in the bond market, is whether another weak jobs report will open the door to a sharp rate cut next month or force the Fed to take an aggressive approach to rate cuts in the coming months. The Fed chairman will speak at 10 p.m. Beijing time on Friday.
"There's an argument to be made that the Fed could cut rates a little faster initially and then slow down," said Matthew Luzzetti, chief U.S. economist at Deutsche Bank. "I think that argument will only really carry weight if there is evidence that the labor market is weakening in a more significant way."
When Powell spoke at Jackson Hole a year ago, he and his colleagues still appeared to be heading in the opposite direction. Fed officials had raised their benchmark interest rate to a range of 5.25% to 5.5% just a month earlier, the highest level in decades.
At the time, Powell described the labor market as tight, called inflation "excessively high" and said the Fed was "prepared to raise interest rates further if appropriate."
Inflation has since eased, and while it remains above the Fed's 2% target, it has fallen significantly. A key measure of core inflation pressures fell for a fourth straight month in July, confirming the downward trend in inflation. "We expect him to acknowledge that the conditions are in place for them to start adjusting policy soon," said Pooja Sriram, an economist at Barclays. "It's not clear whether he will explicitly say September or some other time, but I think the message will be that they appear ready to do so."
Powell's message at this year's Jackson Hole central bank annual meeting may be crucial: The Fed's case for a rate cut in September must be strong enough to counter the political pressure surrounding the Fed during this year's election. This may involve pointing to a slowing job market and weak economic growth. But Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, said he would not want to send an overly negative message about the economic outlook. "To prevent sending negative signals, the Fed needs to be very clear in its communication."
Bond traders have pared back their expectations for Fed rate cuts since a market jolt in early August as risk assets rebounded and recent data, including those pointing to persistently low levels of layoffs and a resilient U.S. consumer, suggested the economy had not fallen off a cliff.
Tight market
Traders currently expect the Fed to cut interest rates by 25 basis points next month and see a total of 75 to 100 basis points of cuts by the end of the year, down from 100 to 125 basis points on Aug. 2.
Asked before the most recent jobs data in July about the possibility of a 50 basis point rate cut, Powell said, “I don’t want to get too specific about what we’re going to do, but it’s not something we’re thinking about right now.”
He and other Fed officials have repeatedly stressed that policy decisions will be "guided" by all the incoming data. They will also get a nonfarm payrolls report and two inflation data before the Fed's Open Market Committee meets on Sept. 17-18.
“Without that information, Powell can’t definitively say at Jackson Hole that they’re going to cut rates by 50 or 25 basis points,” said Lindsay Rosner, head of multi-sector fixed income at Goldman Sachs Asset Management. “He’s going to keep that open and keep his options open, just as he should. That’s his job.”
The theme of this year’s symposium is “Reassessing the Effectiveness and Transmission of Monetary Policy,” an apt theme as many investors and economists are also questioning how quickly interest rate cuts will come in the coming months and at what level the cuts will end.
The nuances of the post-pandemic U.S. economy complicate this consideration. Some Fed officials believe that the neutral interest rate (reflecting a policy stance that neither suppresses nor stimulates the economy) may have risen in the wake of the pandemic, adding to uncertainty about how restrictive Fed policy will be. Warburton said:
“They don’t really know the destination, and I think Powell will highlight that uncertainty and point to the guidance coming from the data. The data will help them determine the destination, and they can slow down or speed up the rate cuts depending on what the economy tells them.”
The article is forwarded from: Jinshi Data
