The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy
Many questions surrounded how Federal Reserve chair Jay Powell would frame his highly anticipated remarks at Jackson Hole on Friday, including the balance between tactical and strategic. In the event, Powell opted for a dual focus in what will be viewed as his second milestone speech, the first being his 2022 eight-minute remarks stressing forthcoming “pain” to the economy.
First, he formalised the widely accepted view that “the time has come for policy to adjust” and that “the direction of travel is clear” and, second, he provided a historical assessment of the 2021-2024 inflation episode that now means that “his confidence has grown that inflation is on a sustainable path back to 2 per cent.”
This approach allows the Fed to retain considerable tactical and strategic optionality. In particular, the well-written Jackson Hole speech resisted the desire of many for Powell to guide on the size of the September cut in interest rates and, more importantly, the destination for these rates. Yet, ironically, the market’s immediate reaction was to push further the notion of aggressive interest rate cuts for a Fed that is still seen as a single-mandate central bank, but with the crucial qualification that it is now focused on avoiding higher unemployment rather than lowering inflation.
Powell was clear about why the time had come for a policy pivot, noting that “the labour market has cooled considerably.” As a result, the balance of risk now sees a diminished threat of higher inflation and “downside risks to employment [that] have increased.” He further stressed that the Fed “do[es] not seek or welcome further cooling in labour market conditions” to dispel any remaining doubts. Strong words for a central bank that, understandably, is cautious about declaring mission accomplished in the battle against an inflation surge that “brought sustainable hardship, especially for those least able to meet the higher costs of essentials like food, housing, and transportation”.
On inflation, the chair acknowledged that the Fed had made a mistake in its initial (2021) assessment that higher inflation would be both temporary and quickly reversible. Still, it was far from the only one. After all, as he points out, “the good ship Transitory was a crowded one, with most mainstream analysts and advanced-economy central bankers on board”.
As interesting as what Powell said is what he refrained from saying and how the markets reacted despite that.
Many of us had hoped that he would go further in seeking to regain the policy and economic narratives. He could have done this by providing greater clarity about where he sees the new neutral interest rate, the journey to that rate, and what is practically meant by the 2 per cent inflation target given the stance of fiscal policy and supply-side conditions. Without that, both the markets and the analyst community will find it hard to exit from their “table tennis narrative” mode that, in less than 30 days, has seen the consensus view shift from a soft landing to a recession that had some advocating loudly for an emergency inter-meeting cut, and back to a soft landing.
While I suspect the Fed desires to cement the policy pivot away from a single-mandate (winning the battle over inflation) to a dual-mandate (price stability and maximum employment), that is not where the market is. Indeed, the immediate market reaction was to push even further on the view that the Fed would cut rates by about 100 basis points in the next four months, with an increased probability for a 50 basis point start in September, and that it would follow that with another 100 basis points in the next six months. Traders are doubling down on the bet of a single-mandate Fed focused on employment and eager to implement “insurance cuts” to materially reduce the probability of a recession.
Going into Jackson Hole, the markets had already been running with the notion of a policy pivot that would result in sizeable rate cuts over the next 12 months. Ironically, Powell’s speech has encouraged them to run even faster and with more confidence. In the process, the markets are ignoring, at least for now, his important concluding remarks that “the limits of our knowledge… demand humility and a questioning spirit focused on learning lessons from the past and applying them flexibly to our current challenges”. In sum, they risk additional market and narrative volatility in the months ahead.
