Jackson Hole – Powell says, time is ripe for rate cuts

25 Aug 2024 , 08:43 AM

WHAT IS JACKSON HOLE SYMPOSIUM ALL ABOUT?

One of the most awaited speeches at Jackson Hole Symposium this year was the speech to be delivered by the Fed chair, Jerome Powell, on August 23, 2024. Since 1978, the Jackson Hole Symposium has been the equivalent of Davos for central bankers. Some of the top central bankers in the world and leading academicians gather at Jackson Hole in Wyoming to debate on the future of the global financial system and to explore ways to align monetary policy globally in a more effective and efficient manner.

The topic for Jerome Powells’ speech was actually quite timid; “Reassessing the Effectiveness and Transmission of Monetary Policy.” However, when Powell spoke at the Jackson Hole Symposium sponsored by the Federal Reserve Bank of Kansas City; the world really wanted to hear an affirmative opinion from Powell on whether the Fed would undertake its first rate cut in September 2024. To be fair, Powell was not just affirmative but also emphatic in his Jackson Hole speech. He said it quite unequivocally that the time was finally ripe for rate cuts, indicating that the first rate would happen in September 2024.

POWELL’S QUICK REVIEW OF THE US ECONOMY

Making a case for embarking on rate cuts from September, Powell underlined that the US economy was much stronger and sounder that it was in the aftermath of the COVID pandemic over 4 years ago. Highlighting the developments since the pandemic, Powell stated that the worst of the pandemic-related economic distortions were fading rapidly leading to significant fall in consumer inflation. For a change, Powell even admitted that the labour market was no longer overheated, and conditions are now less tight than those that prevailed before the pandemic. Even post-COVID supply chain constraints had normalized.

Powell once again underlined that the core mandate of the Fed was to maintain price stability and to maintain a strong labour market. That would mean avoiding any sharp spike in the level of unemployment. One of the biggest achievements of the US economy during the hawkish phase from March 2022 to July 2023, according to Jerome Powell, was that the much-feared hard landing had been totally avoided. He also mentioned that the recent worsening of labour data in July was more an exception and not indicative of any long term trend. Anyways, the sharp spike in unemployment in July 2024 only underlines the urgent need to cut rates in the US economy, so cost of funds is sharply reduced. The Fed chair also underscored that while 2% inflation may look elusive at this juncture, the US economy was firmly and decisively on that path.

SHORT TERM OUTLOOK FOR MONETARY POLICY

Actually, this was the specific segment that the markets really wanted to hear Powell on. Most analysts had warned that any ambivalence in Powell’s speech at Jackson Hole would trigger a sharp sell-off in the US markets. However, with Powell giving indications of the rate cut coming in September 2024, markets should feel largely mollified. Here is what Powell said about the near-term outlook for monetary policy in the US.

• Powell underlined in his speech that during the past 3 years since the middle of 2021, the rate of inflation in the US had been consistently above the 2% mark. In fact, it had been substantially above that mark and only in recent months that it has come to withing 100 bps of the inflation target of 2%. Since the start of 2022, the focus of the US Fed was purely on bringing down inflation to more manageable levels. In fact, the kind of inflation that the US experienced in the aftermath of the pandemic was last seen in the US economy more than 40 years ago in the early 1980s. As Powell pointed out, the reason for the single-minded focus on inflation was that price stability hits the most vulnerable sections of the economy the hardest. You really cannot dispute that.
• Look back at the Fed response to inflation, Jerome Powell underlined that the restrictive (at times ultra-restrictive) monetary policy helped restore balance between aggregate supply and demand. The post COVID inflation surge was caused because governments had infused trillions of dollars to keep demand robust. However, when normalcy was restored, the supply could not catch up immediately due to raw material related supply chain constraints. The prolonged shutdowns in China had only exacerbated the crisis. While there was no option at that point; but to aggressively hike rates to contain inflation, Powell admitted that today his confidence on inflation moving inexorably towards 2% was a lot higher and stronger.
• To understand the labour market in recent years, it is essential to understand the context. For instance, prior to the pandemic, the US economy had seen a long period of strong labour market conditions like low unemployment, high participation, combined with low inflation and healthy real wage gains. In the aftermath of the COVID, the unemployment level touched a low of 3.3%, which is actually better than full employment, but an economic condition not conducive to rate cuts. That situation had changed with the unemployment rising to 4.3% and jobless claims also up.
• What actually tilted the scales in favour of the rate cut preference was the cooling of labour market conditions. Despite job gains staying solid, it has slowed and job vacancies had fallen. The hiring and quits rates are now below the levels that prevailed in 2018 and 2019, while the nominal wage gains had also moderated. All in all, the conditions were finally ripe for the Fed to attempt its first rate cut in September. Despite the cooling labour market conditions, the GDP growth remains robust, recovering from 1.4% in Q1 to 2.8% in Q2 of 2024.
• What does all this mean for near-term monetary policy? In his speech, Powell has said quite categorically that the time has come for policy to adjust. However, while the direction of rates is down from here; Powell emphasized that the timing and pace of rate cuts would be contingent on incoming data and the evolving outlook.

To sum up, the Jackson Hole speech was the second official hint from the Fed (after the minutes) that the US economy was fully poised for its first rate cut in this cycle in September 2024. The CME Fedwatch is pencilling 3-4 rate cuts in 2024 and a total of 200 bps of rate cuts by September 2025. For now, Powell is not willing to commit anything beyond the first rate cut of 25 bps in September 2024.

POWELL ADDRESSES KEY INFLATION ISSUES

In the last few years, the Fed has come in for a lot of flak from analysts and economists. Their objections are not entirely unreasonable. They contend that the Fed was too late to start rate hikes and not it was delay the start of rate cuts. Also, one view is that the Fed tightened too rapidly in a very short time (500 bps tightening in 16 months is a lot). There have also been criticism about the volatility in the Fed guidance and the start differences between the view of the Fed chair and other FOMC members. Also, there were clear sets of hawks and doves in the FOMC, but to be fair, that only makes the debate more interesting. However, Powell has reiterated time and again that policy decisions have to be based on consistent and verifiable data and not on expectations; and his is right. Here are some of the key inflation issues that Powell addressed at Jackson Hole.

• The first question he addressed is the reason for such a sharp spike and later fall in the inflation. While there can be no single reason for such economic phenomena, this could be attributed to the spillover effects of the pandemic. COVID led to shutdowns in economies globally. The US government and the Fed had then responded with the CARES Act. At the Fed, the primary focus was to stave off an economic depression; and for that the benchmark rates were driven straight down to zero levels.
• The subsequent surge in inflation can be attributed to the rapid revival of growth from the third quarter of 2020. The world had been prepared for extended shutdowns, but it emerged that the vaccination and the government had supported had ended the crisis much earlier. The Fed could then have tightened much earlier, but then the US economy and the world economy would have risked a prolonged and delay recovery as we saw in the aftermath of the global financial crisis of 2008.
• According to Powell, the spike in inflation was largely supply driven and that had actually forced the Fed to be a little more cautious in tightening, which explains why they started tightening only in March 2022. A combination of pent-up demand, stimulative policies, and additional savings associated with constrained services spending contributed to a historic surge in consumer spending on goods. This triggered an unprecedented surge in inflation since the last quarter of 2021. However, due to historical reasons and the experience of the GFC, the Fed could act only by March 2022.
• Where the Fed misjudged the economic situation was expecting that the supply situation would ease quickly and automatically. However, that took much longer than expected leading to runaway inflation. It was a classic case of too much money chasing a limited supply of goods and services. Inflation was, therefore, believed to be transitory, which incidentally turned out to be much stickier than at anytime in history. Of course, the Fed cannot be entirely blamed as the core inflation did show signs of falling between April and September 2021. However, from October 2021 onwards, the inflation literally spiralled out of control; forcing a 1981 like situation.
• What changed the narrative for inflation was the Russian invasion of Ukraine in early 2022 and the second and third rounds of COVID attacks, which once again created supply chain constraints. The impact of these factors was only evident by early 2022, when the Fed moved in with the first rate hike in March 2022.

As Powell has pointed out in the past, the focus of the Fed is not just containing inflation, but also ensuring that inflation expectations are anchored. That is essential to ensure that long term inflation stays under check. As Powell best summed it up, the first challenge was to manage sustained rate hikes without triggering a hard landing of the economy. That was achieved. Now, the focus is to cut rates, without triggering inflation once again. That will be the second part of the challenge for the Fed.

POWELL EXPLAINS: KEY THINGS TO KEEP IN MIND

The one thing, according to Powell, that analysts will debate for a long time is how the Fed managed to hike rates by 525 bps without triggering a slowdown in the economy. Here are some thoughts on how this dichotomy was achieved. But, more importantly, Powell feels that it is necessary to appreciate the limits of what the Fed is doing and how there are a plethora of extraneous factors at work.

• According to Powell, while Fed tightening played a role in the control over inflation, without impacting growth, there were also other factors that assisted the Fed. For instance, the post-COVID distortions to supply and demand, as well as severe shocks to energy and commodity markets, were important drivers of high inflation. On a similar vein, when these triggers waned, they had the reverse impact on inflation. So, while Fed policy helped; the automatic adjustment of the supply chain constraints was also a major factor in the inflation coming down. Restrictive monetary policy of the Fed was instrumental in moderating aggregate demand, but the improvements in aggregate supply also played a big role. Markets must not ignore that.
• Powell has time and again emphasized the importance of anchoring inflation expectations. Why does it matter? Inflation expectations are a function of central bank policy. For instance, if the consumers feel relatively confident that the Fed would intervene if required and tame inflation by raising rates, then inflation expectations would be automatically low. If inflation expectations are low, then consumption does not get overtly impacted that has been a key factor in ensuring that the hard landing was avoided. According to Powell, the focus on inflation expectations might have played a critical role in ensuring that the consumption remained robust and did not negatively impact the growth impulses in the economy. These are hare to establish through any causal relationships, but intuitively that looks like a fair explanation.
• According to Powell, a lot of the thinking on monetary policy, inflate and rates is veering around to the view that there is an extraordinary collision between overheated and temporarily distorted demand and constrained supply. That is something most of the analysts and even the economists now appear to concur over. In fact, experts are now attributing most of the incremental inflation to this collision as explained above. However, while the hand of god in the form of supplies adjusting played a part, it must be said that the Fed efforts to moderate aggregate demand, and the anchoring of expectations also added to put inflation on a sustainable path. The US economy may not still be at 2%, but it looks to be progressing towards that.

To sum up, Powell is quite clear that the time is ripe for the first rate cut. However, the Fed is unlikely to give too much credence to the enthusiasm and dovish optimism of the CME Fedwatch. Forget the CME Fedwatch, for the Federal Reserve, it will be “Wait and Watch!”