To The Moon

We expect Federal Reserve Chairman Powell to hint that upcoming data supports the FOMC to begin policy normalization as soon as possible, which almost solidifies the expectation of a rate cut in September. Although we believe Powell won't rule out the possibility of a 50 basis point rate cut in September, he might downplay concerns about the Fed being behind the curve or the U.S. economy deteriorating rapidly. Our base forecast remains a 25 basis point cut. We anticipate that by the end of the year, the Fed will have accumulated a 50 basis point rate cut. However, the risks to this view are becoming more one-sided, with more evident weakness in the labor market potentially challenging the Fed's employment mandate, necessitating further easing.

🚶‍♂️ Step Back Before the Rate Cut: Following the disappointing July jobs data that was not announced at last month's FOMC meeting and the subsequent significant market volatility, the Jackson Hole meeting will provide the Fed and Chairman Powell with an opportunity to fine-tune the message and influence market expectations on the eve of the September FOMC meeting.

Typically, the Jackson Hole meeting serves as a forum for the Fed Chairman to outline policy prospects against a broader historical backdrop. At this juncture, we would not be surprised to see Powell reiterate some elements of the risk management approach he introduced in 2018. At that time, officials were trying to strike a balance between raising rates too quickly and shortening the expansion, and raising rates too slowly and overheating.

Fast forward to now, the risks to balance are between cutting rates too quickly (and undermining inflation progress) and cutting rates too slowly (and harming economic activity). As in 2018, Powell might adopt the Brainard principle (advocating for conservative action when uncertain about the impact of one's actions) when determining the size of the rate cut in September. Although Powell is unlikely to cancel a 50 basis point rate cut in September if data deteriorates, we believe he will advocate for caution, which implicitly can be seen as opposing the idea of initiating the cycle with a 50 basis point rate cut.

In fact, our base forecast remains that the labor market is still solid, which will support a 25 basis point rate cut in September, with an accumulated 50 basis point cut this year. If data changes, our base forecast will change as well. We elaborate below on what we think is needed for further rate cuts.

Finally, confidence in inflation returning to target: We believe a key highlight of Powell's speech will be acknowledging progress in inflation that allows the start of rate cuts. This progress is both quantitative and qualitative.

When Powell speaks, the core PCE inflation rate might be 2.6% year-over-year, compared to 4.3% when he took office last year, peaking at 5.6% in February 2022. Perhaps equally important, this year's deflation is not only from goods but also from housing and non-housing services. As Powell said in July, "This is a broader disinflation."

The July CPI report—and its potential impact on the July PCE report—confirms this progress. These should be the last data points needed by Fed officials before they announce they are more confident that inflation can sustainably rise back to 2%, paving the way for a rate cut in September (see "U.S. July CPI: Looking Good" on August 14).

However, we note that even with recent progress in inflation, by the second half of 2024, core PCE inflation year-over-year will still be affected by unfavorable base effects, meaning that even if the average monthly rate for the rest of this year is only 0.2%, we might see the June year-over-year rate bottom out at 2.6%. In fact, our forecast for core PCE in the fourth quarter of 2024 is 2.7%—only 0.1 percentage point lower than the Fed's median forecast in June (which is consistent with a 4.0% unemployment rate at the end of the year, equivalent to the median participant's forecast for just one 25 basis point rate cut this year).

While we believe Fed officials will focus on short-term momentum, we think they won't completely ignore the year-over-year rate. Powell specifically pointed out at the July press conference that the difficulty of making appropriate seasonal adjustments is one of the reasons the Fed pays attention to the 12-month (i.e., year-over-year) rate.

In other words, although the current inflation trajectory has improved, it still appears consistent with a 50 basis point easing policy this year. The trajectory of the labor market may have more impact.

Back to the dual mandate: Although the work on inflation is not yet complete, we expect this speech to focus more directly on the risks to the employment side of the Fed's mandate. Compared to Powell's last two Jackson Hole speeches, this is certainly correct, and it may also be correct compared to his recent remarks.

The Fed has shifted to a more balanced risk assessment, and at the July meeting, the Fed judged the risks to achieving employment and inflation targets.