CICC's report stated that Federal Reserve Chairman Powell sent a clear rate cut signal at the Jackson Hole meeting, and a rate cut in September is now certain. He pointed out that the risks to employment have increased, the timing for policy adjustment has arrived, and a 25 basis point rate cut is expected. If non-farm data remains weak, a 50 basis point rate cut is also possible. Powell emphasized that inflation risks have diminished, and he has greater confidence in achieving the 2% inflation target, paving the way for future rate cuts
According to the Zhitong Finance and Economics APP, CICC released a research report stating that Federal Reserve Chairman Powell sent a clear signal of interest rate cuts at the Jackson Hole meeting, and a rate cut in September is now certain. Powell emphasized that the downside risks to employment have increased, the timing for policy adjustment has arrived, and the Fed will do everything possible to support the labor market. However, he did not express any views on the magnitude and speed of the rate cut, leaving room for future actions. The baseline scenario is still that the Fed will cut rates by 25 basis points in September, but if non-farm data unexpectedly weakens again, a 50 basis point cut is also possible. The market reacted positively to Powell's early announcement of rate cuts, as it addressed concerns about the Fed "lagging behind the curve". Wall Street believes that if the labor market continues to weaken, the Fed will not hesitate to take action.
The background of this year's Jackson Hole meeting is the slowdown in U.S. inflation, but with a slight increase in the unemployment rate. The market is concerned that the Fed's policy is "behind the curve" and hopes to get more clues about the future rate cut path from Powell.
Firstly, as expected by the market, Powell sent a clear signal of interest rate cuts, and a rate cut in September is now certain. Powell focused on the labor market conditions in his speech, stating that the downside risks to U.S. employment have increased. Although the recent rise in the unemployment rate mainly reflects an increase in labor supply and a slowdown in previous aggressive hiring, the cooling in the labor market is undeniable. He cited examples such as the significant slowdown in job growth, a decrease in job vacancies at companies, and lower hiring and quit rates compared to pre-pandemic levels, indicating that the labor market is no longer tight. Powell further stated that the Fed is neither seeking nor welcoming further cooling in the labor market, and the timing for policy adjustment has arrived. While further achieving price stability, the Fed will do everything possible to support a strong labor market. Regarding inflation, Powell mentioned that the upside risks to inflation have diminished, and expressed stronger confidence in inflation falling back to the 2% target. These remarks indicate that the Fed is prepared for rate cuts, and the Fed's monetary policy has shifted from solely combating inflation to balancing inflation and stable employment.
Chart: Increased downside risks to U.S. employment
Source: Haver, CICC Research Department
Chart: Decreased upside risks to U.S. inflation
Source: Haver, CICC Research Department Secondly, although Powell announced the rate cut in September in advance, he did not provide any indication of the magnitude and speed of the rate cut. Prior to this, the market had already fully priced in the rate cut for September. The real issue now is the magnitude and speed of the rate cut, but Powell did not offer any guidance on these issues. Powell mentioned in his speech that the specific timing and pace of the rate cut will continue to depend on economic data, maintaining his consistent cautious approach and leaving room for flexibility in future rate cuts. From this perspective, Powell's speech did not provide much incremental information. Therefore, our base case scenario is still that the Fed will cut rates by 25 basis points in September, but if the August non-farm data unexpectedly weakens again, a 50 basis point rate cut is also possible.
Looking ahead, due to the expansion of the U.S. fiscal policy, the Fed's monetary easing space will be limited in the medium term. By the end of 2023, the market had expected a fiscal contraction in the U.S. in 2024. However, in June, the U.S. Congressional Budget Office (CBO) raised the deficit rate for the 2024 fiscal year by 1.4 percentage points to nearly 7%, indicating that the U.S. fiscal policy has not tightened this year but continues to expand. Fiscal expansion will increase economic resilience and inflation stickiness, hindering Fed rate cuts. On the other hand, it means that government debt issuance will increase, leading to more bond supply and upward pressure on interest rates. Given this, in the absence of fiscal tightening, we expect the magnitude of Fed rate cuts to be limited, meaning that the downward space for interest rates will also be limited.
Thirdly, since there is not much incremental information, why did the U.S. stock market soar? One explanation is that Powell's remarks effectively addressed the market's concerns about the Fed's policy "lagging behind the curve," allowing investors to sense the "Fed put" option. Previously, the market was concerned that the Fed's rate cut was taking too long, increasing the risk of an economic hard landing. For example, in July, the unemployment rate unexpectedly rose from 4.1% to 4.3%, triggering the Sam rule and causing concerns about a recession and a sharp drop in U.S. stocks. Although these concerns were later proven to be excessive, with U.S. stocks quickly rebounding after the sharp drop, the market still hoped that Powell could provide reassurance. Today, Powell repeatedly mentioned his vigilance towards the labor market conditions, easing market concerns with this dovish attitude. Wall Street believes that if the labor market weakens further, the Fed will not hesitate to take action. Powell also reminded in his speech that the Fed's current policy rate level provides sufficient space to address any risks that may arise, including the risk of further deterioration in labor market conditions.
Furthermore, Powell's remarks also strengthened market confidence in an economic soft landing, which helps boost risk appetite. Powell spent a considerable amount of time in his speech reviewing the formation of inflation and the difficult process of combating inflation over the past four years, especially analyzing how inflation slowed down without a significant increase in the unemployment rate. Powell pointed out that post-pandemic improvements in supply-side factors, Fed rate hikes to suppress total demand, and efforts to control inflation expectations have collectively driven inflation steadily downward while maintaining strong employment. This analysis indicates that Powell believes the possibility of the U.S. achieving a soft landing is increasing In history, the soft landing of the U.S. economy often comes with a series of "lucky" positive supply shocks. This time, the rapid recovery of the global supply chain alleviates supply pressure, increased immigration inflow boosts labor supply, and new formats and technologies such as remote work and artificial intelligence (AI) enhance labor productivity, all creating favorable conditions for a soft landing