The Big Picture
Briefing.com Summary:
*Hawkish fears fizzled after Fed Chair Powell's speech signaled a nod toward policy easing.
*Fed Chair Powell leaned more on employment risk than inflation risk.
*The market had a textbook response to a speech it viewed as being more dovish-minded.
Leading up to Fed Chair Powell's speech at the Jackson Hole Symposium, a fuse had been lit in the fed funds futures market that was burning away at the probability of a 25 basis-point rate cut at the September 16-17 FOMC meeting. Specifically, the probability had been trimmed to 71.3% from 92.1%, as there was a budding fear that Fed Chair Powell might ignite a bomb with a hawkish-sounding speech.
That fear began to build after the release of the July Producer Price Index, and it continued to build following recent remarks from other Fed officials signaling their reluctance to cut rates and the release of the minutes for the July 29-30 meeting, which stipulated that the majority of participants judged the upside risk to inflation as greater than the downside risk to employment.
That was before the release of the July Employment Situation Report, which showed large downward revisions for May and June that left the three-month average for nonfarm payrolls at a lowly 35,000.
In listening to Fed Chair Powell's speech, he sounded more attentive to the downside risk to employment than the upside risk to inflation. Accordingly, he snuffed out the fuse, and the only bomb that went off was the one that got dropped on short sellers.
A Handshake Deal
The stock market has been clamoring for a rate cut, and it now believes (again) that it will get one at the September FOMC meeting, barring some real inflation shock in the August CPI and PPI reports or a major upward surprise for August nonfarm payrolls, all of which will be released before the September FOMC meeting.
In the wake of Fed Chair Powell's speech, the probability of a 25 basis-point rate cut in September returned to north of 90.0%, stock prices surged, with small-cap stocks leading the charge, the 2-yr note yield dropped 10 basis points to 3.68%, and the U.S. Dollar Index declined 0.9% to 97.70.
Those are textbook responses for a market anticipating a friendlier interest rate environment. Just how friendly the Fed gets remains to be seen, but the market effectively has a handshake deal with Fed Chair Powell on a rate cut in September.
So, what was said that prevented things from blowing up?
- Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.
- 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.
- 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.
- A reasonable base case is that the effects [of tariffs] will be relatively short-lived—a one-time shift in the price level.
- Given that the labor market is not particularly tight and faces increasing downside risks, that outcome [workers demanding and getting higher wages] does not seem likely.
- Measures of longer-term inflation expectations, however, as reflected in market- and survey-based measures, appear to remain well anchored and consistent with our longer-run inflation objective of 2 percent.
- Our policy rate is now 100 basis points closer to neutral than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance.
- In the absence of inflationary pressures, it might not be necessary to tighten policy based solely on uncertain real-time estimates of the natural rate of unemployment.
These remarks are not arranged in any specific order, although it is fair to say that the remark following the first bullet point is what kept the bomb from detonating. That was Fed Chair Powell's tacit signal to the market that he is on board with a rate cut in September based on what he knows today.
Briefing.com Analyst Insight
It is possible that the employment and inflation reports for August light the fuse again, yet that determination will have to wait.
Fed Chair Powell reminded everyone, however, that the Fed cannot take the stability of inflation expectations for granted and that it will not allow a one-time increase in the price level to become an ongoing inflation problem. That was a nod toward the understanding that tariffs, and any related price adjustments, could still become problematic if they force a shift in inflation expectations, meaning the Fed would operate with a restrictive policy if that was the case.
That case will be litigated at another time. The market wanted one thing and one thing only out of the Jackson Hole speech. It wanted a signal that a September rate cut is more likely than not.
Fed Chair Powell delivered the goods in that respect. Consequently, the stock market rallied, feeling a great deal of relief that Fed Chair Powell didn't ignite a fire in the hole.
