Fed policy and finding balance between inflation and the job market.
When my boys were young, I remember their preschool and kindergarten teachers noting that they needed to work on developing better adaptability to transitions. As the teacher explained it, changing gears from playing outside on the swings and slides or in choice time with trains and trucks and then switching to sitting down at a desk and working on phonics or drawing a picture was not their strong suit. I remember having heart-to-hearts with each of my sons about why phonics and drawing were as important as slides and trains. While surely skeptical, they solemnly nodded and promised to do their best, mostly because they loved me and saw the urgency of my plea. Eventually, they fell in with the crowd, and switching gears became more seamless even if their hearts longed to be shooting down slides or running across fields.
Federal Reserve Chairman Jay Powell’s speech at Jackson Hole, Wyoming, at the Fed’s annual economic policy symposium was widely anticipated to be a conversation about transitions, much like my heart-to-heart with my boys. And Powell did not disappoint; in his speech this morning, he gave an indication (albeit a tepid one) of possible interest rate cuts ahead, pointing to the high level of uncertainty that’s making the job difficult for monetary policymakers.
In his prepared remarks, Powell said that “sweeping changes” in tax, trade and immigration policies mean “the balance of risks appear to be shifting” between the Fed’s dual goals of full employment and stable prices. While he noted that the labor market remains in good shape and the economy has shown “resilience,” he said downside dangers are rising. At the same time, he said tariffs raise the risk of rising inflation—a stagflation scenario that the Fed needs to avoid.
But with the Fed’s benchmark interest rate a full percentage point below where it was when Powell delivered his keynote a year ago, and the unemployment rate still low, he said that current conditions allow “us to proceed carefully as we consider changes to our policy stance. Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.”
The markets are taking these statements as a sign that interest rates will be cut, potentially as soon as the next Federal Open Market Committee meeting taking place on Sept. 16 and 17. Powell did not provide any hints of the ultimate level of policy changes, but some market experts believe the Fed could reduce interest rates by as much as 1% to 1.25% over the next year.
That is certainly what President Trump would like to happen. On that point, while not addressing White House demands for lower rates specifically, Powell did note the importance of Fed independence: “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.”
In addition to summarizing the current conditions and potential outcomes, the speech touched on the Fed’s five-year review of its policy framework. The review resulted in several notable changes from when the central bank last performed the task in 2020.
In the midst of the Covid-19 pandemic, the Fed switched to a “flexible average inflation targeting” regime that effectively would allow inflation to run higher than the Fed’s 2% goal coming after a prolonged period of holding below that level. The upshot is that policymakers could be patient with slightly higher inflation if it resulted in a more comprehensive labor market recovery.
However, shortly after adopting the strategy, inflation began to climb, ultimately hitting 40-year highs, while policymakers largely dismissed the rise as “transitory” and not requiring rate hikes to manage. Powell noted the damaging impacts from the inflation and the lessons learned.
“As it turned out, the idea of an intentional, moderate inflation overshoot had proved irrelevant. There was nothing intentional or moderate about the inflation that arrived a few months after we announced our 2020 changes to the consensus statement, as I acknowledged publicly in 2021,” Powell said. “The past five years have been a painful reminder of the hardship that high inflation imposes, especially on those least able to meet the higher costs of necessities.”
Also during the review, the Fed reaffirmed its commitment to its 2% inflation target. There have been critics on both sides of the issue, with some suggesting the rate is too high and can lead to a weaker dollar, while others seeing a need for the central bank to be flexible.
“We believe that our commitment to this target is a key factor helping keep longer-term inflation expectations well anchored,” Powell said.
All told, Powell’s Jackson Hole address was quite deft, providing a measured assessment of the risks and a careful, controlled approach to the Fed’s eventual response. Powell remains unflappable in the face of criticism from the West Wing, and the market likes the “both/and” it received today: Both a commitment to independence, and a measured outlook for some adjustments to interest rates. As a result, markets are soaring as I write this, recovering from some uncertainty and sideways trading earlier in the week, especially the most expensive and highly valued companies in the technology and communications sectors.
I started this note mentioning transitions, and I had a big personal one occur this week when I dropped my oldest son off for his freshman year of college. As I sat on his empty and fully made bed at home this morning, feeling a lot sorry for myself, I imagined the rumpled bed at school, and the clothes now dropped on the floor of his new dorm room. I imagined him happily running off to breakfast with his friends at the dining hall, and wished I could have one last argument about waffles or cereal. Even so, I am bursting with pride and love and excitement for him as he starts this new stage and adventure.
Transitions are hard, in this case probably hardest on mom, but in the broader context, they bring doubts as much as excitement. It would be no surprise if the stock market, euphoric today, ends up feeling less so once investors grasp what interest rate cuts say about the economy slowing down from its expansion phase while inflation pressures remain. It is going to be a balancing act, but it always is. It is for you too, and please know we stand ready to support you in your planning through both market and personal transitions, always striving for the perfect balance.
Written by a human.