The Fed Chair’s speech at the Jackson Hole symposium is always acutely relevant for investors, and it proved so once again this year. There were always going to be two key parts to this: the short-term outlook, on one hand, and changes to the policy framework, on the other.
In respect to the first, Chair Powell came across a little more dovish than we had dared hope. We welcome this, given our view that rate cuts are needed. Prior to the speech, we would have said that the data still needed to convince the FOMC to cut in September. After the speech, we would say that it needs to convince the FOMC not to cut. The big negative revisions to payrolls earlier this month have clearly shifted the balance. We may well move from dissents in favor of a cut in July to dissents in favor of a hold in September, but the center of gravity has shifted closer toward a cut. To be fair, Chair Powell only said that the outlook “may warrant adjusting” the policy rate. However, the lack of obvious caveats made this sound less like a possibility and more like a promise—one that markets evidently liked, with both equities and bonds up sharply.
There was a subtle hint to the political backdrop and ongoing open pressure from the administration toward rate cuts in Chair Powell’s reminder that “FOMC members will make these decisions, based solely on their assessment of the data and its implications for the economic outlook and the balance of risks. We will never deviate from that approach.” Concise and clear; just the right touch.
As to the strategy review, this is a perfect example of vision always being 20/20 in hindsight. Back in 2019/2020, with a decade of struggles with low inflation and operating at the effective lower bound (ELB), the Fed introduced several innovations to its policy approach, all of which have now been essentially reversed. Below is a summary of the latest changes.
- Instead of viewing ELB as a “defining feature of the economic landscape,” there is a commitment to “promote maximum employment and stable prices across a broad range of economic conditions” (our emphasis).
- Return to a pure form of average inflation targeting, without intentionally “making up” inflation shortfalls, since the need to do so has been rendered obsolete by post-Covid experiences.
- Maximum employment is no longer specifically described as a “broad and inclusive” concept but rather as “the highest level of employment that can be achieved on a sustained basis in a context of price stability.”
- Focus shifts from mitigating “shortfalls” back to the original approach of mitigating “deviations” in employment relative to the estimated equilibrium level. This was a practical choice to avoid communication challenges. The Fed remains primarily concerned about employment shortfalls but does not want that to be interpreted as “a commitment to permanently forswear preemption or to ignore labor market tightness.”
The changes were non-controversial and largely expected and bring the Fed back to the general approach followed pre-Covid. There is more of a two-sided approach to risks that could improve policy responsiveness.