Policy pivot
Powell adopts dovish tone in his Jackson Hole keynote
Published August 23 2024
BOTTOM LINE
With inflation trending lower and with the labor market softening, Federal Reserve Chair Jerome Powell believes that it is now appropriate for the Fed to end its monetary policy pause and begin to cut interest rates.
“The time has come for policy to adjust,” Powell said in his speech this morning at the Kansas City Fed’s annual monetary policy symposium in Jackson Hole, Wyoming. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”
We expect the Fed to orchestrate its first quarter-point cut at its next policy-setting meeting on September 18, to be followed by another such cut on December 18 and in each quarter over the course of 2025.
Inflation getting back on track Powell pointed out that the Fed’s preferred measure of inflation (the Personal Consumption Expenditures index, or core PCE) has fallen from 5.6% at its peak in February 2022 to 2.6% in June 2024. “My confidence has grown that inflation is on a sustainable path back to 2%,” he said.
Over the past three years, the central bank raised the fed funds rate from near zero to an upper band of 5.5% in July 2023 and reduced its balance sheet from $9 trillion to $7.2 trillion, which have contributed to the slower pace of inflation.
Left unsaid, however, is that in its most recent Summary of Economic Projections (SEP) in June, the Fed forecast core PCE to increase to 2.8% y/y by year end 2024, before eventually grinding lower to its 2% target by year-end 2026. At the same time, wholesale inflation (the core Producer Price Index, or PPI) has risen from 1.8% in December 2023 to 2.4% in July 2024.
So, it’s unlikely, in our view, that the Fed entertains a more aggressive half-point interest rate cut next month, as the Fed awaits calmer inflation data in coming months. In contrast, retail inflation (the nominal Consumer Price Index, or CPI) has favorably diverged, plunging from a 41-year high of 9.1% in June 2022 to 2.9% in July 2024.
Politically agnostic Historically, the Fed prefers not to adjust monetary policy in presidential election years after Labor Day, unless they deem it necessary, to avoid even the appearance of impropriety. That suggests the Fed is likely to opt for the smaller quarter-point cut next month.
Fed’s dual mandate coming into focus In addition, Powell noted that the labor market has cooled considerably from its overheated state during the aftermath of the Covid recovery. The official rate of unemployment (U-3) has soared from a 53-year low of 3.4% in April 2023 to a three-year high of 4.3% in July 2024, triggering recession concerns as the Sahm Rule states if U-3 rises 0.5% or more on a rolling 3-month basis within a year, the economy typically slows into a recession.
“Labor market conditions are now less tight than just before the pandemic in 2019 – a year when inflation ran below 2%,” Powell said. “It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon. We do not seek or welcome further cooling in labor market conditions.”
Downward revisions To complicate this discussion, the Labor Department on Wednesday announced that monthly payroll data overstated job growth by 818,000 nonfarm payroll jobs over the past 12 months through March 2024. So, employers added an average of about 174,000 jobs per month, 28% below the previously reported 242,000 jobs.
“Inflation and labor market data show an evolving situation,” Powell said, explaining the Fed’s Phillips Curve tradeoff. “The upside risks to inflation have diminished. And the downside risks to employment have increased.”
“With the appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2% inflation while maintaining a strong labor market,” he concluded.
Why is Jackson Hole important? This prestigious monetary-policy symposium, which was started by the Kansas City Federal Reserve in 1978, routinely draws top central bankers from around the world to discuss important global economic issues. This year’s theme was “Reassessing the Effectiveness and Transmission of Monetary Policy,” and the Fed chair typically delivers a high-profile keynote speech to discuss important monetary-policy thoughts.
Buy the rumor, sell the news? The S&P 500 and the NASDAQ Composite have soared by more than 10% and 14%, respectively, over the past three weeks, as many investors anticipated the Fed’s dovish tone during today’s Jackson Hole address. At the same time, benchmark 10-year Treasury yields have declined from nearly 4.30% a month ago to 3.80% today. Historically, stocks tend to correct once the Fed begins to cut interest rates, reflecting the expecting slowdown in both economic and corporate profit growth. Given the current valuation imbalance between stocks and bonds, we could see an equity-market consolidation of 10% or so in coming months.
“Humility at the highs…” “The limits of our knowledge – so clearly evident during the pandemic – demand humility and a questioning spirit focused on learning lessons from the past and applying them flexibly to our current challenges,” Powell concluded.
Chair Powell has seemingly ripped a page from the book of our own equity CIO Steve Auth, who regularly opines that we must espouse “confidence at the lows, humility at the highs, and integrity always.”