Powell will send a strong signal! But the market may not be satisfied

The Jackson Hole Economic Symposium has always been an important date on the Federal Reserve's agenda. However, Ethan Harris, former Global Chief Economist at Bank of America and former Chief US Economist at Lehman Brothers, pointed out that in recent years, the meetings in Wyoming have been like an additional meeting of the FOMC, for the following reasons.

First, unlike testifying in Congress, Fed Chairman Powell can manage policy expectations without dealing with political attacks or irrelevant topics.

Second, the meeting is held during the summer holiday period, limiting communication among Fed officials.

Third, there is usually a long gap between the July and September Fed meetings.

Fourth, compared to his predecessors, Powell seems to communicate more systematically with the Fed Board of Governors. This makes it easier for him to speak with confidence knowing he has the support of other monetary policy makers.

Finally, the message of patience that the Fed is currently conveying to the market is quickly becoming outdated.

Powell may send a strong signal in his speech on Friday: a 25 basis point rate cut in September.

The Fed's restraint at the beginning of the year made sense, as the US core PCE had been strong for four consecutive months. Since then, inflation data has softened for three consecutive months, giving policymakers the confidence to cut rates. The significant downward revision to job growth announced by the Bureau of Labor Statistics also provides more reasons for a rate cut. There will only be one more set of employment and inflation data released before the September meeting, so the risk of the Fed canceling the rate cut is extremely low.

In recent weeks, the market's pricing of the Fed's interest rate policy has been all over the place. Powell warned investors at the press conference after the July meeting not to overreact to individual data.

Pricing of the Fed's rate outlook has seen unusual volatility due to weak employment reports, strong retail sales reports, and the sell-off in US stocks, but people seem to be turning a deaf ear to this. At the peak of panic, some analysts even advocated for the Fed to cut rates between meetings and/or take more aggressive rate cuts.

The current market pricing is more reasonable than two weeks ago, but Harris still believes that the Fed will not be as dovish as most people expect.

The market still expects a significant 50 basis point rate cut by the Fed in September, with virtually zero possibility of keeping rates unchanged. Furthermore, the market anticipates that from now until the end of 2025, the Fed will cut rates by 25 basis points at almost every meeting.

Such a large rate cut only makes sense in a scenario where US monetary policy is extremely tight and the economy is likely to experience a recession. In recent months, "recession" has become a popular term, but understanding the history of recessions is crucial. Every modern economic recession has been caused by tight financial conditions or external shocks such as commodity price shocks from the COVID-19 pandemic. Over the past year, both financial markets and the economy have shown they can withstand rates of over 5%.

The gradual slowdown in economic growth is almost exactly what the Fed hopes for. As a result, the Fed needs to readjust its policy to bring the federal funds rate to around 4%, the historical average level This is why Powell may signal a 25 basis point rate cut and continue to hint at a gradual easing cycle. As shown in the chart below, Harris expects the Fed to cut rates by 25 basis points four to five times next year. This appears to be a mid-term correction rather than a major policy reversal.