On August 23, Federal Reserve Chairman Jerome Powell made a bombshell speech at the annual meeting of global central banks in Jackson Hole. He said: The time has come for policy adjustments. The timing and pace of rate cuts will depend on subsequent data, changes in the outlook and balance of risks.

He believes that the current level of policy rates gives the Fed ample room to respond to any risks it may face, including the risk of further deterioration in labor market conditions. "The upside risks to inflation have diminished, while the downside risks to employment have increased. The Fed is concerned about the risks to each of its dual missions. ”

The probability of a 25 basis point rate cut in September also remained stable

In his recent speech, Powell made it clear that "the time has come for a policy adjustment." The policy direction is clear, and the timing and pace of rate cuts will depend on subsequent data, changes in the outlook and risk balance. ”

Although Powell confirmed the market's broad expectation of a rate cut in September, his speech was seen by analysts as "dovish", which provided some clarity to financial markets in the short term. However, Powell did not reveal more specific clues on how the Fed will act after the September meeting, such as whether there will be a large 50 basis point rate cut due to a negative jobs report, or whether there will be sustained rate cuts in the coming months.

Nevertheless, Powell's speech confirmed at least one fact: the Fed is approaching a critical turning point in its fight against inflation over the past two years. Powell concluded his prepared speech, and the possible Q&A session that followed was not livestreamed.

Following Powell's speech, swap traders' forecasts for the total amount of rate cuts by the end of 2024 remained unchanged at around 98 basis points. The probability of a 25bp rate cut in September also remained stable.

In terms of market reaction, the major US stock indexes continued to gain gains. The S&P 500 rose more than 1% an hour after the opening hour, and the Dow Jones Industrial Average rose 400 points at one point. The tech-heavy Nasdaq and the more cyclically sensitive Russell 2000 small-cap index were particularly outperforming, rising 1.5% and 2%, respectively. In addition, the U.S. regional bank index rose 5%, its biggest gain in eight months. At the same time, United States Treasury yields and the dollar index briefly fell, in line with market expectations that the Fed is about to cut interest rates.

Inflation will continue to return to 2%.

Powell began by mentioning that the worst economic distortions caused by the pandemic are receding in the four and a half years since the pandemic began. Inflation has fallen sharply, the labor market is no longer overheated, and the current economic conditions are more accommodative than before the pandemic. Supply constraints have returned to normal.

He said the Fed's goal is to restore price stability while maintaining a strong labor market to avoid a repetition of the high unemployment rates of the early deflationary period amid volatile inflation expectations. "Four and a half years after the pandemic, the worst economic distortions caused by the pandemic are receding. Inflation has fallen sharply, the labor market is no longer overheated, and conditions are now looser than before the pandemic. Supply constraints have been normalized. Our goal is to restore price stability while maintaining a strong labor market and avoiding a sharp rise in unemployment during the early tightening period in the face of less volatile inflation expectations. ”

Powell then spoke about the current state of inflation, praising the progress made in cooling inflation: "After the pause earlier this year, we started to move towards the 2% target again. I am increasingly confident that inflation will return to 2% on a sustainable basis. This is due to the fact that contractionary monetary policy has helped restore the balance between aggregate supply and aggregate demand, easing inflationary pressures and ensuring that inflation expectations remain stable, he explained. Inflation is now closer to the 2% target, having been at 2.5% over the past 12 months.

Commenting on the job market, Powell said: "Now that the labor market has cooled significantly from its previous overheating state, it seems unlikely that the labor market will be a source of rising inflationary pressures in the near term." We do not seek or welcome further cooling of labour market conditions. He noted that the United States nonfarm unemployment rate began rising more than a year ago and is now at 4.3%, which is still low by historical standards, but almost a full percentage point higher than at the beginning of 2023, with most of the rise in unemployment occurring in the past six months.

Overall, Powell's speech suggests that the Fed will continue to seek a balance between its dual mission, especially at a time when inflation is returning to target and unemployment remains relatively low, and the Fed wants to maintain steady growth through appropriate monetary policy without compromising the health of the labor market.

High inflation is starting to reverse

In his speech, Powell reviewed the measures taken by the Fed since 2022 to combat high inflation. At the beginning of 2022, the headline inflation rate in the United States exceeded 6%, the core inflation rate exceeded 5%, and the new supply shocks brought about by the Russia-Ukraine conflict and the resurgence of the epidemic made high inflation a global problem. Together, people have experienced rapid growth in demand for commodities, tight supply chains, tight labor markets, and a sharp rise in commodity prices.

United States inflation peaked at 7.1% in June 2022, while labor shortages were severe, although employment increased by more than 6.5 million from mid-2021 during this period.

In light of this, the Fed has made the fight against inflation a top priority, starting with aggressive interest rate hikes in March 2022. In 2022, the Fed has raised interest rates by a cumulative 425 basis points; The rate hike will continue by 100 basis points in 2023, and the benchmark interest rate has remained at its highest level in more than two decades since July 2023. This series of measures has reduced inflation by 4.5 percentage points from its peak two years ago, and the unemployment rate has remained low, a phenomenon that is very rare in history.

Powell pointed to the distortions in supply and demand caused by the pandemic, as well as severe shocks to energy and commodity markets, as important drivers of high inflation. As these factors faded, so did inflation, albeit much longer than expected.

"Our contractionary monetary policy has led to a moderation in aggregate demand, which, combined with an improvement in aggregate supply, has reduced inflationary pressures while allowing economic growth to continue at a healthy pace. As labor demand has eased, the high ratio of job vacancies to the number of unemployed has returned to normal, mainly through a decline in the job vacancy rate, without large-scale and disruptive layoffs, so that the labor market is no longer a source of inflationary pressures. ”

Powell stressed that the supply and demand distortions during the pandemic and shocks in energy and commodity markets are important causes of high inflation, and the reversal of these factors is a key component of the decline in inflation.