Market attention is focused! What kind of "shock" will Powell bring on Friday?

On Friday, Federal Reserve Chairman Powell will deliver a speech at the annual Jackson Hole meeting, which will kick off the next phase of the Fed's fight against inflation. He is expected to pave the way for rate cuts while assuring investors that policymakers can avoid a significant economic slowdown.

This highly anticipated speech will take place at a time when the Fed and the $27 trillion U.S. Treasury market are facing high risks. Powell and his colleagues seem poised to cut rates just 7 weeks before the U.S. presidential election, a risky task that will put the Fed chair and his colleagues under close public scrutiny. This also comes as officials, after years of focusing on price pressures, are increasingly turning their attention to a cooling labor market.

Joseph Brusuelas, Chief Economist at RSM US LLP, said:

"The question is, will we make a policy mistake? That's why the market is so uncertain around Jackson Hole, we need to hear from Powell the Fed's stance on potential policy shifts."

Investors have been on edge, trying to predict the speed and magnitude of future rate cuts. July's labor market data triggered significant market volatility in early August, with the S&P 500 falling over 6% in three trading days. U.S. Treasuries rose, with traders for days predicting a 50 basis point cut by the Fed in September.

The rationale for a September rate cut by the Fed must be strong

Powell and his colleagues have made mistakes before. They failed to act promptly to curb rising inflation during the pandemic, leading Fed officials to now be determined to avoid a similar disaster in employment as price pressures ease. But the unexpectedly strong and historically significant job market seems to be showing cracks.

Last month, U.S. employers slowed their hiring pace, with the unemployment rate rising for the fourth consecutive month, raising concerns that high rates may be starting to crack the labor market. Several economists also expect a significant downward revision to employment data for the year ending in March to be announced on Wednesday.

For those watching Powell's speech, especially in the bond market, a key question is whether another weak employment report will open the door to a significant rate cut next month, or force the Fed to take aggressive easing measures in the coming months. The Fed chair will deliver the speech at 10 p.m. Beijing time on Friday.

"There's a debate that the Fed could start cutting rates a bit faster at the outset and then slow down," said Matthew Luzzetti, Chief U.S. Economist at Deutsche Bank. "I think that argument only really gains weight when there's evidence that the labor market is weakening in a more pronounced way."

A year ago, when Powell spoke at Jackson Hole, he and his colleagues seemed to be moving in the opposite direction. Fed officials had raised the benchmark interest rate to a range of 5.25% to 5.5% just a month earlier, the highest level in decades When Powell described the labor market as tight and inflation as "too high," he stated that the Fed is "prepared to further raise interest rates under appropriate circumstances."

Since then, inflation has eased somewhat, although it remains above the Fed's 2% target, it has significantly decreased. A key indicator measuring core inflation pressure has declined for the fourth consecutive month in July, confirming the downward trend in inflation. Barclays economist Pooja Sriram said, "We expect him to acknowledge that the conditions are in place for them to start adjusting policy soon. It is not yet clear whether he will explicitly state whether it will be in September or another time, but I think the message will be that they seem prepared to do so."

The information Powell conveys at this year's Jackson Hole central bank symposium may be crucial: the reasons for the Fed's rate cut in September must be strong enough to address the political pressure surrounding the Fed during this year's election. This may involve pointing out a slowdown in the labor market and weak economic growth. However, Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives, said, he would not want to send overly negative signals about the economic outlook, "To avoid sending negative signals, the Fed needs to be very clear in its communication."

Since the market turbulence in early August, with the rebound of risk assets and recent data (including indications that layoffs remain low and the resilience of U.S. consumers), bond traders have reduced their expectations of Fed rate cuts.

Tight Markets

Traders currently expect the Fed to cut rates by 25 basis points next month, with a total of 75 to 100 basis points by the end of the year, lower than the 100 to 125 basis points on August 2.

Before the release of the most recent employment data in July, when asked about the possibility of a 50 basis point rate cut, Powell said, "I don't want to be too specific about the actions we will take, but that is not something we are considering now."

He and other Fed officials have repeatedly emphasized that policy decisions will be "guided" by all upcoming data. Ahead of the September 17-18 FOMC meeting, they will also receive a non-farm payroll report and two inflation data.

"Without this information, Powell cannot definitively state at Jackson Hole whether they will cut rates by 50 or 25 basis points," said Lindsay Rosner, head of multi-sector fixed income at Goldman Sachs Asset Management. "He will maintain this openness, retain the option, as he should. That's his job."

The theme of this year's symposium is "Reassessing the Effectiveness and Transmission of Monetary Policy," which is an appropriate theme as many investors and economists are also questioning how quickly rate cuts will come in the coming months and at what level they will end The subtle differences in the US economy after the COVID-19 pandemic have made this consideration complex. Some Federal Reserve officials believe that the neutral interest rate (reflecting a policy stance that neither restrains nor stimulates the economy) may have risen after the outbreak of the pandemic, intensifying uncertainty about how restrictive Federal Reserve policy really is. Warburton stated:

"They really don't know the destination. I think Powell will emphasize this uncertainty and point out guidance from the data. The data will help them determine the destination, and they can slow down or accelerate the pace of interest rate cuts based on what the economy tells them."