In a dovish speech at the Fed’s Jackson Hole conference, Chair Jay Powell signalled in plain language that a rate cut is coming at the September meeting – but said that the timing and pace would depend on the incoming data. Consistent with market expectations, Powell expressed more confidence in the inflation outlook and put more emphasis on downside risks in the labour market, where he said any further weakening would be “unwelcome.” We expect that the FOMC will deliver a 25bp cut in September, but a 50bp cut is possible if further labour data is unexpectedly soft.
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Powell expressed confidence in the inflation outlook and put emphasis on downside risks in the labour market, noting that “the balance of the risks to our two mandates has changed.” On inflation, Powell said that “progress toward our 2% objective has resumed,” “the upside risks to inflation have diminished,” and his “confidence has grown that inflation is on a sustainable path back to 2%.” His remarks contrast with more tentative recent statements on inflation from some other FOMC participants, and that means he does not think it is appropriate for the FOMC to be held back any longer by inflation concerns.
Powell struck a dovish tone on the labour market and more firmly emphasized that the Fed’s tolerance for labour market cooling had reached its limits, and any further weakening would be “unwelcome.” He characterized the rise in the unemployment rate as “almost a full percentage point”, noted that “downside risks to employment have increased.” Powell did not sound alarmed, however, noting as we have that the increase in the unemployment rate has been driven by “a substantial increase in the supply of workers” rather than “elevated layoffs,” and that the pace of hiring is no longer “frantic” but is still “solid.”
We expect the FOMC to deliver an initial string of three consecutive 25bp cuts at the September, November, and December meetings. Powell’s speech last Friday that the FOMC has “ample room to respond to any risks we may face” reinforces the view that the FOMC’s tolerance for further signs of softness in the labour market has run out and that it would act more aggressively if the labour market cools further.
Without doubt this is the news that the markets have been waiting for and it is not surprising that they have rallied in response. Past patterns suggest that markets perform well once rate cuts get underway.
