By Jen Saarbach & Kristen Kelly, Co-Founders of The Wall Street Skinny
Going into Jackson Hole, it felt like the market was primed for disappointment. But Powell delivered. What happened?
We started the day with an exuberant market priced to perfection. Expectations that the Fed will cut interest rates at their September meeting seem fully embedded in nearly all asset valuations. Yet after a spate of surprisingly high inflation data, it seemed highly likely to me that Fed Chairman Jerome Powell might equivocate somewhat on the mixed signals in the market, preserving optionality over the course of the next month.
He did no such thing. In his remarks, Powell said:
Overall, while the labor market appears to be in balance, it is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers. This unusual situation suggests that downside risks to employment are rising. And if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment.
At the same time, GDP growth has slowed notably in the first half of this year to a pace of 1.2 percent, roughly half the 2.5 percent pace in 2024. The decline in growth has largely reflected a slowdown in consumer spending. As with the labor market, some of the slowing in GDP likely reflects slower growth of supply or potential output…
…The effects of tariffs on consumer prices are now clearly visible. We expect those effects to accumulate over coming months, with high uncertainty about timing and amounts. The question that matters for monetary policy is whether these price increases are likely to materially raise the risk of an ongoing inflation problem. A reasonable base case is that the effects will be relatively short lived—a one-time shift in the price level.
Chair Jerome H. Powell
TL/DR: Powell is emphasizing the downside risks to employment over the potential upside risks to inflation, giving a firm justification for a 25bp ease in September. On the spectrum of Fed language, this was a clear proclamation that the Fed is adopting a more dovish stance.
The market’s response? Nothing short of jubilation.
Risk assets are up across the board led by equities, 2 year yields immediately dropped 10 basis points, and the dollar is weakening, all consistent with affirmation that a rate cut is nigh.
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And I should have learned my lesson. Last September when the Fed, cut 50 basis points rather than the 25bps the market was anticipating, I was caught off guard (along with many of the world’s most prominent investors and economists). I thought Powell would want to preserve optionality in the face of conflicting data at the time rather than making a big move. But it seems instead his M.O. is to respond decisively to weakness in the data market.
The title of the Jackson Hole symposium this year is, after all, “Labor Markets in Transition: Demographics, Productivity, and Macroeconomic Policy”. Addressing the softening labor market head on, knowing full well how the market would interpret his remarks, Powell has now left VERY little room for optionality next month.