The Kansas City Fed’s Economic Policy Symposium in Jackson Hole, Wyo., on Friday presented Federal Reserve Chairman Jerome Powell with an occasion to give investors and policymakers the words that they wanted to hear on a possible September rate cut.
Powell more than delivered by noting, “The baseline outlook and the shifting balance of risks may warrant adjusting our policy stance,” which opens the door to one or more near-term rate cuts pending labor market and inflation data.
The Powell pivot toward a possible rate cut is now predicated on the August jobs data that will be published on Sept. 5 and is likely show a weak report of below 50,000 jobs given what appears to be a new breakeven rate that Powell pointed to in his statement.
Powell noted the stability of the unemployment rate and other labor market measures while noting a marked slowing in both the supply of and demand for workers—an unusual situation that suggests that downside risks to employment are rising.
Powell was also careful to note that in the near-term, inflation risks are tilted to the upside and risks to the employment are to the downside, which strongly suggests tensions within the Fed’s dual mandate of price stability and maximum sustainable employment.
Investors should not underestimate the current tension within the dual mandate. Should hiring modestly reaccelerate or float between 50,000 and 100,000 per month, it will be difficult to justify further rate cuts as inflation moves away from the 2% target.
In our estimation, this denotes some risk around a one-and-done scenario with respect to a possible September rate cut should inflation continue to move away from its 2% target.
Fed’s new framework
Powell outlined a shift in the Federal Reserve’s operating framework to a symmetrical bias around both sides of their dual mandate. This new framework moves from an asymmetrical bias that tilted toward full employment by letting inflation run above target following years of sub-2% inflation.
By linking the framework to a balanced 2% target, the Fed is likely to be more preoccupied with inflation gaps that form above the 2% target, which one can correctly construe as a hawkish bias on setting rates, keeping inflation expectations entrenched and pushing inflation back toward its 2% target.
The takeaway
The Fed opened the door to a rate cut in September and that will be the baseline expectation until all concerned get a look at the jobs data for August.
That potential policy pivot should bolster equity valuations, send prices up and yields down across the Treasury curve, and possibly set the stage for further rate cuts should job growth come in below 50,000 per month or the unemployment rate increase.
Perhaps more important, the Fed’s policy framework will be focused on inflation gaps above the 2% target following years in which the Fed was more focused on maximum sustainable employment.
This means that years of a policy framework that was focused on the risks around the zero lower boundary of rates, undershooting the 2% inflation target and raising employment has ended.
By returning to a focus on price stability and a 2% inflation target, this new framework implies that all concerned should prepare for higher rates for longer despite the rising probability of near-term rate cuts.
