The major dovish turn of the Federal Reserve triggers a global asset frenzy

Source: Wall Street News

Authors: Du Yu, Li Dan, He Hao

On Friday, August 23, Fed Chairman Jerome Powell said at the annual meeting of the Jackson Hole Global Central Bank that it was time to adjust policy, not seeking or welcoming the continued cooling of the job market, and my confidence in inflation falling to 2% has increased, confirming the market’s expectation that Powell will deliver a “dovish” speech.

Analysis suggests that Fed Chairman Powell’s policy shift is complete. Powell showed a fully dovish stance in his speech, compared to the same period two years ago when he said the Fed would accept an economic downturn as the price of restoring inflation.

Powell’s dovish turn in his speech pushed the S&P close to a new high, with small-cap and chip stocks rising by about 3% and major indices rising by more than 1% for the week, with small caps leading the way. On Friday, TSL and Nvidia rose by more than 4.5%, regional bank stock ETFs rose by more than 6% at one point. Short-term US bond yields plummeted by double digits, the US dollar fell by 1.7% for the week, spot gold rose by more than 1% to surpass $2510, the pound hit a near two-and-a-half-year high, the yen rose by more than 1%, offshore renminbi rose by more than 300 points, and oil rose by more than 2%.

The Fed’s significant dovish turn, Powell clearly stated: It’s time to adjust the policy.

At 10 a.m. on Friday, August 23, U.S. Eastern Time, Federal Reserve Chairman Powell made a major statement at the Jackson Hole Global Central Bank Annual Meeting.

It is worth noting that Powell was quite clear in saying, “The time for policy adjustment has come. The policy direction has been determined, and the timing and pace of interest rate cuts will depend on subsequent data, changes in outlook, and risk balance.”

Some analysts believe that although Powell confirmed the market’s widespread expectation of a rate cut in September, this speech was also “dovish,” providing some clarity to the financial markets in the short term, but not providing many clues as to what the Fed will do after the September meeting.

For example, if there is another negative employment report, whether there will be a substantial 50 basis point rate cut, and whether the rate cuts will continue in the coming months. However, Powell’s remarks at least confirmed that the Fed’s struggle with inflation over the past two years is reaching a critical turning point.

Powell finished reading the prepared speech, and the possible Q&A session was not live-streamed. The market’s expectation for the total interest rate cut by the end of 2024 remains at around 98 basis points. The probability of a 25 basis point rate cut in September also remains stable.

In the market reaction, the US stock index continues to expand, with the S&P 500 rising by over 1% in the first hour of trading, the Dow rising by 400 points at one point, and the tech-heavy Nasdaq and the more economically sensitive Russell 2000 leading the way, rising by 1.5% and 2% respectively. The US regional bank index soared by 5%, marking the largest surge in eight months, while the US bond yields and the US dollar index took a short-term nosedive, all related to the logic of the impending Fed rate cut.

The economic seminar attended by Powell is titled ‘Reassessing the Effectiveness and Transmission of monetary policy’. His speech not only reviews the shift in balance between the two major missions of ‘employment and prices’ of the Fed after the epidemic, clarifies how future policy directions should be adjusted, but also attempts to clarify why the unemployment rate can remain low even when inflation drops significantly.

He first pointed out that the risk balance faced by the Fed’s two major tasks of “maintaining price stability” and “achieving full employment” has changed, and emphasized the importance of stabilizing the labor market at the current stage when inflation continues to fall to the 2% target:

"Four and a half years after the outbreak of the COVID-19 pandemic, the most severe economic distortions caused by the pandemic are receding. Inflation has dropped significantly, the labor market is no longer overheated, and the current conditions are looser than before the pandemic. Supply restrictions have returned to normal.

Our goal is to restore price stability while maintaining a strong labor market, avoiding a sharp rise in the unemployment rate in the early period of monetary tightening when inflation expectations are not quite stable.

When it comes to inflation, Powell praised the progress of inflation cooling, saying, “After a pause earlier this year, we have resumed our march toward the 2% target. I am increasingly confident that the inflation rate will sustainably return to the 2% level.”

He believes that this is mainly due to the tightening monetary policy that helped restore balance between total supply and demand, eased inflationary pressures, ensured stable inflation expectations, and made “inflation now closer to our target, with prices pumping 2.5% in the past 12 months.”

When evaluating the job market, he asserts, “Nowadays, the labor market has cooled significantly from its previous overheated state, and it seems unlikely that the labor market will become a source of inflationary pressure rise in the short term. We neither seek nor welcome further cooling of the labor market conditions.”

Specifically, the US non-farm unemployment rate has been rising for over a year, currently at 4.3%, which although still very low by historical standards, is nearly a full percentage point higher than at the beginning of 2023, with most of the rise occurring in the past six months.

But Powell tried to defend the current robustness of the US economy, saying:

"So far, the rise in unemployment has not been the result of an increase in layoffs, which is common during economic downturns. Conversely, the rise in the unemployment rate largely reflects a significant increase in the supply of workers and a slowdown in the pace of previously frenzied hiring.

Nonetheless, the cooling of the labor market is also evident. Employment remains solid but has slowed this year. Job vacancies have declined, and the ratio of job vacancies to unemployed has returned to pre-pandemic levels. Nominal wages have slowed their rise. Overall, the labor market is not as tight as it was before the outbreak in 2019, when inflation was less than 2%.

Overall, the economy continues to rise steadily (solid). However, the inflation and labor market data indicate that the situation is changing. The upward risk of inflation has weakened, while the downward risk of employment has increased. The Fed faces the risks of its dual mandates.

Powell then stated that the Fed “will do everything in its power to support a strong labor market while further achieving price stability,” and explicitly pointed out that rate cuts are the future policy direction:

"With the appropriate reduction of policy restrictions, we have every reason to believe that the economy will return to 2% inflation while maintaining a strong labor market. Our current policy Intrerest Rate level provides ample room to respond to any risks we may face, including the risk of further deterioration in labour market conditions. ”

In the second part of the speech, Powell devoted more space to discussing the rise and fall of inflation before and after the COVID-19 pandemic, and explored why inflation could decrease significantly while the unemployment rate remained low, seemingly continuing to depict a rare “soft landing” for the U.S. economy.

However, according to some analysis, during the COVID-19 pandemic, the Federal Reserve failed to raise interest rates in a timely manner to cope with the surge in inflation. Powell’s remarks highlight that, in the current slowdown of price rise, Fed officials hope to avoid making policy mistakes again. Their success or failure will determine whether the Fed can achieve the so-called ‘soft landing’, which means suppressing the surge in inflation without causing an economic recession.

Using the platform of the Jackson Hole Global Central Bank Annual Meeting, Federal Reserve officials repeatedly hinted that a rate cut is imminent. Apart from Fed Chairman Powell, who sounded dovish, other officials either supported the view that the economic environment does not require tightening, or stated how the rate cut should be done.

Philadelphia Fed President Harker repeatedly mentioned on Thursday and Friday that interest rates should be lowered “in an orderly manner”; Chicago Fed President Evans said that the Fed not only needs to fight inflation, but it is time to follow employment; now that the currency is quite tight and the economy is not overheating, there is no need to tighten monetary policy; Atlanta Fed President Bostic said that we cannot wait until inflation has completely dropped to 2% before taking action, and there may be more than one interest rate cut this year.

“New Fed News Agency” calls on Powell to turn, hinting at opening the door to larger rate cuts

Federal Reserve Chairman Powell completely unleashed the dovish attributes at this year’s Jackson Hole Central Bank annual meeting, according to the latest assessment by Nick Timiraos, a senior reporter and the so-called ‘New Fed News’ of the Federal Reserve report throat.

On the morning of Friday, August 23rd, Eastern Time, after Powell’s speech, Timirao commented on social media X:

“Powell has completed a policy shift. Two years ago, Powell hinted that the Fed would accept an economic recession in exchange for inflation returning to normal. Now, his stance has become fully dovish.”

Next, Timiraos listed the following sentences from Powell’s speech to prove his dovish tendencies, including:

“The cooling of the labor market conditions is obvious.”

“The labor market is unlikely to be the source of short-term inflationary pressure rise.”

“We do not seek nor welcome further cooling of the labor market conditions.”

"The time has come for policy adjustments. The policy direction is clear, and the timing and pace of rate cuts will depend on subsequent data, changes in the outlook and balance of risks. ”

“We will do our best to support a strong labor market while making further progress in price stability.”

The Wall Street Journal noticed that although there was no separate article to comment on Powell’s speech, Timiraos’s X forwarded a link to a report. The latest report in which he contributed content pointed out that recently, some Fed officials have used relatively obscure terms such as “gradual” and “orderly” to express their expectation that the Fed will have a series of 25 basis point rate cuts.

Although Powell’s explanation of the Fed’s interest rate cut target was convincing, he did not specifically explain how to achieve this goal. He completely avoided using words like ‘gradual’ and ‘orderly.’ By not mentioning this, Powell has opened the door for a larger rate cut in the coming weeks once there are more serious signs of weakness in the labor market.

The article also pointed out that compared to the speech at the press conference after the Fed meeting at the end of July, Powell’s stance this time was not so vague. At that time, he said that the Fed needed more data to be sure that inflation was falling. Friday’s speech indicated that he now has that data.

Timiraos mentioned in another post on X some other impressive sentences from Powell’s speech this time. Among them, when explaining the causes and behavioral performance of inflation since 2020, Powell realized that not everyone would agree with his framework, so he concluded, “This is my assessment of the situation. Your views may differ.”

Under this post, the top-liked comment from a netizen reads, I am glad it’s not an emergency rate cut this time.

US ‘Inflation Whistleblower’: The Fed has recovered from severe inflation mistakes, but has made an incorrect prediction about the neutral interest rate

On Friday, the ‘inflation whistle-blower’ and former US Treasury Secretary Summers said that although the Fed failed to act quickly to address the surge in US inflation in 2021, hitting a low point in its monetary policy history, it ultimately made sufficient efforts to correct the economy.

Sommers said, “I must commend the Fed. Although it is not always obvious, they have taken strong and proactive actions to maintain inflation expectations stable. We all make a lot of mistakes. The important thing is to recognize them and correct them when you make a mistake.”

Shortly before Summers spoke, Federal Reserve Chairman Powell announced on the same day that it is now time for a policy adjustment because consumer prices pump have cooled down, inflation risks have weakened, and employment risks have increased. Powell also admitted that the initial assessment that inflation would be “transient” in the spring of 2021 was proved wrong later that year.

Although Summers said that it is the right move for the Fed to cut interest rates at the September meeting, he also believes that more caution is needed for the mid-term outlook of monetary policy.

Sommers said he would be surprised if the Fed drops the Interest Rate to the level expected by the market, that is, the Derivatives market shows that the Benchmark Interest Rate will drop to about 3% in the next two years. The current target range for the federal funds Interest Rate is 5.25%-5.5%.

When it comes to the estimated long-term Benchmark Intrerest Rate by Fed policymakers, Summers pointed out that their expectations are below 3%, which is still too low. Due to the large fiscal deficits in the United States and strong investments in the green economy and advanced technologies, these all put pressure on borrowing costs, and the so-called neutral Intrerest Rate may be higher than in the past.

Summers said bluntly, “I think the Fed made a serious mistake in assuming that the neutral interest rate is so low, thus misjudging the restrictiveness of any given policy level. If you don’t have the right North Star, you can’t navigate accurately.”