Jackson Hole Economic Symposium: Powell Will Make Policy Direction Clear, But Nothing More

The highly anticipated annual central bank conference - the Jackson Hole Economic Symposium - commenced on August 22 for a three-day duration. The complete agenda was released at 8 p.m. New York time on August 22. Each year, the schedule has some variations, but it typically includes panel discussions featuring central bank governors from around the globe, alongside officials from international organizations such as the International Monetary Fund (IMF) and the Bank for International Settlements (BIS). This year's theme, "Reassessing the Effectiveness and Transmission Mechanisms of Monetary Policy," underscores the significance of the event, particularly within the context of global economic recovery from the COVID-19 pandemic, elevated interest rates, and geopolitical tensions.

However, this year's "Global Central Bank Annual Meeting" appears to lack substantive participation, with only the Federal Reserve Chairman and the Governor of the Bank of England (BOE) confirmed to attend and speak. Notably, European Central Bank (ECB) President Christine Lagarde is expected to miss this year's meeting, with her place being taken by the ECB's Chief Economist, Philip Lane.

Powell will deliver a speech regarding the economic outlook via livestream, which is typically regarded as a keynote address. Bailey will present the luncheon speech, while Lane from the ECB is set to participate in a review panel discussion on Saturday, possibly engaging in dialogue with central bank governors from emerging markets and leaders of international organizations. Although Bank of Japan Governor Kazuo Ueda participated in panel discussions last year, he has been requested to attend a parliamentary meeting on the 23rd this year, and thus will not be present.

The most highly anticipated event is undoubtedly the address by Fed Chairman Powell, as he usually clarifies the "medium-term policy trajectory" during such meetings, even in the absence of actual policy announcements (for instance, during Bernanke's term, he would "forecast" new policies). This speech will also outline future areas of concern.

In recent years, the Fed has made erroneous assessments at crucial moments, but following a period of "reflection," it is evident that there has been "progress" in this regard.

During the tumultuous repurchase market of 2019, the Fed's interest rate management range once went out of control, ultimately requiring the revival of repurchase tools to provide liquidity. Notably, in his speeches that year, Powell failed to mention any aspect of the money market. The Fed's policy communication was heavily criticized, as reflected in a market survey conducted by the New York Fed, where only one primary dealer deemed the Fed's communication "relatively effective." Meanwhile, eight found it "average," eleven categorized it as "very ineffective," and four dismissed it as having "no (or low) effectiveness." Among the twenty-eight surveyed market participants, eight described the Fed's communication as "relatively effective," five considered it "average," seven labeled it as "very ineffective," and another seven identified it as having "no (or low) effectiveness," with only one participant rating it as "very effective."

The speech from 2020 was closely related to the adjustments in the Fed's framework at that time, establishing a foundation for monetary policy over the next decade. During his address, Powell extensively discussed the impact of the low productivity, low inflation, and low unemployment since the 2008 financial crisis on monetary policy. He referenced the well-explored concept of the flattening of the Phillips Curve, which seemingly justified the Fed's shift toward an average inflation-targeting regime. However, Powell clearly overlooked the onset of the pandemic in the same year and the aggressive shifts in fiscal policy. In reality, the post-pandemic era has numerous structural challenges for the labor market, while inflation has become exceptionally high and uncontrollable, making it difficult for the new framework to adapt to the current economic landscape and labor market conditions. Consequently, discussions on average inflation targeting had largely fallen by the wayside, and the highly politically correct notion of a "broad employment objective" within the new framework has become nearly forgotten.

By 2021, when the meeting convened, inflation in the U.S. had already begun to rise, while fiscal stimulus efforts continued at a significant scale from 2020. In his speech, Powell emphasized that "inflation is transitory", attempting to substantiate this claim with five key arguments and extensive elaboration to convey that inflation was manageable within the Fed's control and that a decrease would occur by the year's end. The subsequent developments are well-known; not only did inflation fail to decline, but it continued to rise.

In the 2022 speech, it was evident that Powell learned from previous experiences, particularly from 2021, and firmly established a notably hawkish tone regarding the "medium-term policy path," characterized by "slower, longer, and higher."

Fed Chairman Powell underscored the necessity of addressing inflation while also noting the deceleration of the labor market and economic growth. Many developments aligned with expectations; however, the requirement to maintain interest rates below 4% by 2023 seems to be significantly at odds with the current rate levels in the context of employment elasticity.

Overall, the decisions made by the Fed appear to be correct. Therefore, this meeting has humorously been dubbed the "Fed's moment of self-reflection." It is worth mentioning that the theme of the Jackson Hole Economic Symposium in 2022 was "Reassessing Constraints on the Economy and Policy," which closely resembles this year's theme.

In 2023, the persistent inflationary pressures, uncertainties surrounding the economic recovery process, and fluctuations in the global economic environment have set the primary tone. During this meeting, Powell's remarks predominantly focused on inflation and the economy, while also underscoring the importance of maintaining a hawkish stance and not ruling out the possibility of future interest rate hikes. Overall, there is greater caution regarding the approach to inflation.

Whether the Fed's policy in 2023 is "correct" depends on whether inflation has effectively come down, but also takes into account the performance of economic growth and the job market. From the current point of view, it is undoubtedly correct.

Since the beginning of this year, the Fed has faced a number of challenges. Initially, inflation showed signs of rebounding, leading both the market and the Fed to view this as merely a "bump" in the disinflation process. However, after three consecutive months of increasing inflation, market sentiment began to shift - from perceiving it as a "bump" to acknowledging a rebound in inflation, then recognizing a stall in the disinflation efforts, and ultimately interpreting it as a reversal in inflation trends. Fortunately, starting from the April CPI, the market gradually began to believe that the disinflation process was progressing sustainably.

However, just as the inflation issue seemed to be resolving, complications arose in the labor market. The unemployment rate in the non-farm payrolls for May and June began to climb, reaching 4.3% in July - the highest level since October 2021, and almost triggering the "Sahm Rule." According to the Sahm Rule, if the unemployment rate (based on a three-month SMA) rises by 0.5 percentage points above its low from the previous year, a recession has begun. This indicator has accurately predicted economic downturns 100% of the time since 1970. Consequently, concerns over a potential recession began to permeate the market. The Fed explained that the rise in the July non-farm unemployment rate was likely attributed to an increase in the labor force population coupled with a decrease in hiring demand. It was only through comments from several Fed officials and the recent positive performance of various economic data that worries about a recession began to dissipate.

Throughout this process, whether dealing with inflation or labor market issues, the Fed has been actively guiding expectations through "expectation management." However, despite these efforts, the market still anticipates a 100-basis-point rate cut by the Fed by the end of the year. Judging from the speeches made by two FOMC officials at the Jackson Hole Economic Symposium yesterday, one supports a rate cut, while the other agrees with discussing the magnitude of the cut.

Boston Fed President Susan Collins stated that it would soon be appropriate to start cutting rates to help maintain a still-healthy labor market.

Philadelphia Fed President Patrick Harker mentioned that upcoming economic data in the next few weeks will help determine the appropriate magnitude of the first rate cut. He emphasized the need to review several weeks of data before deciding whether a 25 or 50 basis point rate cut is warranted in September.

From these two officials' remarks, it appears that the Fed has reached a consensus internally on the timing of rate cuts, but there is still disagreement over the magnitude of the cuts. This is one of the main reasons the market is focusing so closely on Fed Chair Jerome Powell's speech.

Considering the Fed's performance in the last two meetings and its recent attitude, Powell's speech might not be as hawkish as the market expects, as the market often likes to "jump the gun," which is not what Powell wants to see. Another piece of evidence supporting this is the previous remarks made by the two officials—one hawkish and one dovish (relatively speaking)—which seems to serve as a "precaution" for the market.

The market might hear more comments similar to those made in early August, such as avoiding reactions to single-month data and continuing to observe the broader trends. Key data like the PCE (Personal Consumption Expenditures) and the August non-farm payroll report will be released shortly after the Jackson Hole Economic Symposium, which may emphasize the need to wait for these data before deciding on the extent of easing required.

Simultaneously, there might be assurances that if the economy takes a more severe downturn, the Fed is prepared to act swiftly.

In summary, Powell might not be ambiguous about the direction but will indicate that the speed and timing of rate cuts will depend on the data between now and the next meeting. According to the minutes from the July meeting, unless unexpected events occur, the "vast majority" of members support a rate cut in September. The remaining question is whether the cut will be 25 or 50 basis points. This is actually somewhat predictable, with regional Fed Presidents like Harker being reluctant to reveal specifics, let alone Powell.

There are other clues suggesting that a 50 basis point rate cut might be feasible. Although the U.S. economy is currently weakening, the real economy has not yet experienced a crisis. At the same time, considering the risk of inflation possibly rebounding—especially as the economy may further recover after a rate cut—the Fed might still be concerned about inflation rising again. Therefore, the Fed may take a more cautious approach, opting for a 25 basis point cut as an initial move, rather than being too aggressive at the outset.

However, from the perspective of benefiting the economy and financial markets, a larger 50 basis point cut might be more advantageous. A key question regarding the current understanding of the U.S. economy is: Why hasn't the U.S. economy entered a recession after such a rapid rate hike to high levels? So far, there hasn't been a substantial financial recession in the U.S. The main reason behind this is that financial institutions and the government have protected the household and corporate sectors by taking on risks themselves. Therefore, during the entire rate hike process in the U.S., the accumulated risk has been more financial rather than a risk to economic growth.

The current liquidity in the U.S. is not lacking; it's just that the cost of funds is relatively high. Based on this, we believe that a more substantial, preventive rate cut would be more effective in alleviating financial risks. Otherwise, high interest rates might not truly resolve the risks.

This is why some officials, such as Harker, are open to a 50 basis point rate cut. In theory, the current environment in the U.S. supports a 50 basis point rate cut by the Fed, but due to uncertainties, in practice, the Fed might lean towards a more cautious 25 basis point cut as a more realistic initial step.

Additionally, as mentioned earlier, the Fed has made misjudgments during this economic cycle, mainly in underestimating the persistence of inflation in its early stages. Powell initially believed that inflation was temporary, but it turned out he was wrong. Late last year and early this year, the Fed thought that inflation had dropped to a level where rate cuts could be considered, but subsequent events proved this judgment wrong again. In other words, the Fed's misjudgments have more to do with the resilience of the economy rather than whether it has entered a recession. The robust growth of the U.S. economy in this cycle has actually given the Fed considerable confidence.

Although there has been a slight deterioration in the employment situation, it is unlikely to evolve into a large-scale recession. Therefore, discussing whether it is too late to cut rates might be inaccurate. Employment data from the first or second quarter, or even GDP growth, were somewhat overheated. The Fed might choose to delay the rate cut and proceed cautiously.

Even if a rate cut occurs in September, it might be more of a preventive measure rather than a crisis response. With non-farm payrolls not showing a sharp decline and the Fed still having substantial policy space, the notion of a rate cut being too late might not hold. Instead, the market’s anticipation and demand for a rate cut might be premature.

As for the impact on the U.S. Dollar Index, it is expected to decline, but the drop may be limited. Although Powell might clarify the policy direction at this meeting, the market has already priced this in. Considering the market's tendency to anticipate prematurely, Powell might be more cautious in his wording, which could disappoint some investors who are looking for signs of a 50 basis point rate cut. This could provide upward momentum for the dollar, but ultimately, due to a clear policy direction, the dollar index is likely to end lower.