The time has come for rate cuts

Each year, the Federal Reserve Bank of Kansas City hosts the Jackson Hole Economic Symposium, attended by global central bankers, policymakers, economists, and academics. Given the topics covered on the yearly agenda and the prominence of the attendees, markets pay close attention to the speeches made at the Symposium and, in particular, the opening remarks of Federal Reserve Chairman Jerome Powell.

Chair Powell did not disappoint. He opened the symposium by signaling that the long-awaited start to the Fed’s cutting cycle will begin in September—and that downside labor market risks now have their full attention.

To summarise the key points of Powell’s speech:

1. The Fed now has greater confidence that inflation is on a sustainable path back to the 2% target.
2. The critical key to their success in bringing inflation down without triggering significant economic pain has been keeping inflation expectations well anchored.
3. As inflation risks have subsided, labor market risks have grown. While the Fed allocates much of the recent increase in unemployment rate to a rise in labor supply, Powell also noted the “unmistakable” cooling in labor market conditions. It’s worth noting that a Fed research paper, presented today at the Jackson Hole Symposium, notes that the labor market is approaching a tipping point whereby further cooling could trigger a more significant increase in the unemployment rate.
4. With increased confidence in the path of inflation, the Fed’s focus has clearly shifted to the labor market side of its dual mandate. Importantly, Powell emphasized that they will not tolerate any further weakening in labor market conditions.
5. Despite this forceful nature of his comments around incoming rate cuts (“the time has come for policy to adjust”), Powell did not provide any guidance as to the magnitude of policy cuts. Instead, the Fed will continue to be data dependent.
6. Our interpretation is that, if the August jobs report (to be released on September 6) shows a rise in monthly job gains to above 150k and the unemployment rate retreats slightly from 4.3%, the Fed will only cut rates by 25bps. On the other hand, if the August jobs report confirms July’s weakness, the Fed will respond with a 50bps cut. This is consistent with our own policy projection—we expect the Fed to deliver a 25bps cut in September but, if the August jobs report is weak, a 50bps cut will become our baseline.
7. Powell emphasized that the Fed has ample room to cut rates if so required.

Markets have responded to Powell’s speech with delight. They are now pricing in 100bps of rate cuts by year-end, potentially equivalent to a 50bps cut in September, and a 25bps cut in both November, and December. If the jobs data comes in stronger and the Fed responds with a 25bps cut in September, it is possible that the market will react with disappointment, despite the more reassuring labor market backdrop.

Overall, however, the key takeaway from today should be one of relief. With the Fed alert to labor market risks and ready to start cutting rates, recession risk should start abating.

Principal Asset Management