Powell's major shift, global asset frenzy

Author: Du Yu, Li Dan, He Hao, Wall Street Insights

On Friday, August 23, Federal Reserve Chairman Jerome Powell "dovishly" stated at the Jackson Hole Global Central Bank Annual Meeting that it is time to adjust policies and that he does not seek or welcome further cooling of the labor market. His confidence in inflation returning to 2% has strengthened, confirming market expectations that Powell would deliver a "dovish" speech.

Analysts suggest that Powell's shift in policy has been completed, as he exhibited a comprehensive dovish stance in his speech. Two years ago, during the same period, he indicated that the Federal Reserve would accept an economic recession as the cost of restoring inflation.

Powell's significant dovish pivot brought the S&P 500 close to a new high, with small-cap and chip stocks rising about 3%. Major indices rose over 1% for the week, with small caps performing the best. On Friday, Tesla and Nvidia rose over 4.5%, and regional bank stock ETFs surged over 6% at one point. Short-term U.S. Treasury yields plummeted, the dollar fell 1.7% for the week, spot gold rose over 1% to above $2,510, the pound hit its highest level in two and a half years, the yen rose over 1%, offshore yuan gained over 300 points, and oil prices increased over 2%.

01 Major Dovish Shift by the Federal Reserve: Powell Clearly States: It’s Time to Adjust Policies

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

Notably, Powell explicitly stated: "The time for policy adjustment has come. The direction of policy is clear, and the timing and pace of rate cuts will depend on subsequent data, changes in outlook, and risk balance."

Some analysts noted that while Powell confirmed the market's broad expectations for a rate cut in September, his speech was also "dovish," providing some clarity to financial markets in the short term, but did not offer much insight into how the Federal Reserve would act after the September meeting.

For instance, if another negative employment report comes out, will there be a significant rate cut of 50 basis points, and will there be continued rate cuts in the coming months? However, Powell's remarks at least confirmed that the Federal Reserve's struggle with inflation over the past two years is approaching a critical turning point.

After reading his prepared remarks, the potential Q&A session was not broadcast live, and swap traders maintained their prediction for a total rate cut of about 98 basis points by the end of 2024. The probability of a 25 basis point cut in September also remained stable.

In market reactions, U.S. stock indices continued to rise, with the S&P 500 gaining over 1% within the first hour of trading, and the Dow Jones Industrial Average rising by as much as 400 points. The tech-heavy Nasdaq and the more economically sensitive Russell small-cap stocks led the way, rising 1.5% and 2%, respectively. The U.S. regional bank index surged 5%, marking its largest gain in eight months, while U.S. Treasury yields and the dollar index dropped sharply, both related to the logic of "the Federal Reserve is about to cut rates."

The economic seminar Powell attended was titled "Reassessing the Effectiveness and Transmission of Monetary Policy." His speech not only reviewed the shift in balancing the Federal Reserve's dual mandate of "employment and prices" post-pandemic but also pointed out how future policy directions should be adjusted, while attempting to clarify why the unemployment rate could remain low despite a significant decline in inflation.

He first noted that the risk balance facing the Federal Reserve's two main tasks of "maintaining price stability" and "achieving full employment" has changed, emphasizing the importance of stabilizing the labor market at this stage where inflation continues to decline towards the 2% target:

"Four and a half years after the outbreak of COVID-19, the most severe economic distortions caused by the pandemic are fading. Inflation has significantly decreased, the labor market is no longer overheating, and current conditions are more accommodative than before the pandemic. Supply constraints have normalized.

Our goal is to restore price stability while maintaining a strong labor market, avoiding a sharp rise in unemployment during the early tightening period when inflation expectations are less stable."

When discussing inflation, Powell praised the progress in cooling inflation, stating, "After pausing earlier this year, we are again moving towards the 2% target. I am increasingly confident that the inflation rate will sustainably return to the 2% level."

He believes this is mainly due to the tightening monetary policy helping to restore the balance between aggregate supply and demand, alleviating inflationary pressures, and ensuring that inflation expectations remain stable, making "inflation now closer to our target, with prices rising 2.5% over the past 12 months."

In evaluating the labor market, he asserted, "Today, the labor market has significantly cooled from its previous overheating state, and it seems unlikely that the labor market will become a source of rising inflationary pressures in the short term. We do not seek or welcome further cooling of labor market conditions."

Specifically, the U.S. non-farm unemployment rate has risen from over a year ago and currently stands at 4.3%. While still low by historical standards, it is nearly a full percentage point higher than at the beginning of 2023, with most of the increase occurring in the past six months.

However, Powell attempted to defend the robustness of the current U.S. economic situation, stating:

"So far, the rise in the unemployment rate has not resulted from an increase in layoffs, which is common during economic downturns. Instead, the rise in the unemployment rate mainly reflects a significant increase in the supply of workers and a slowdown in the previously frantic hiring pace.

Even so, the cooling of labor market conditions is evident. Job growth remains solid but has slowed this year. Job vacancies have decreased, and the ratio of job vacancies to unemployed individuals has returned to pre-pandemic levels. Nominal wage growth has slowed. Overall, the labor market is not as tight as it was before the pandemic in 2019, when inflation was below 2%.

Overall, the economy continues to grow steadily. However, inflation and labor market data indicate that the situation is changing. The upside risks of inflation have diminished, while the downside risks to employment have increased. The Federal Reserve is focused on the risks facing each of its dual mandates."

Powell then stated that the Federal Reserve "will do everything possible to support a strong labor market while further achieving price stability," clearly indicating that rate cuts are the future policy direction:

"By appropriately reducing policy constraints, we have ample reason to believe that the economy will return to a 2% inflation rate while maintaining a strong labor market. Our current policy rate level provides sufficient space to address any risks we may face, including the risk of further deterioration in labor market conditions."

In the second part of his speech, Powell devoted more time to discussing the fluctuations of inflation before and after the COVID-19 pandemic and explored why inflation could significantly decline while the unemployment rate remains low, seemingly continuing to depict that the U.S. economy may achieve a rare "soft landing."

However, some analysts noted that during the COVID-19 pandemic, the Federal Reserve failed to raise interest rates in a timely manner to address soaring inflation, and Powell's remarks highlight that amid the current slowdown in price growth, Federal Reserve officials hope to avoid making policy mistakes again. Their success or failure will determine whether the Federal Reserve can achieve the so-called "soft landing," which means curbing soaring inflation without pushing the economy into recession.

Using the platform of the Jackson Hole Global Central Bank Annual Meeting, Federal Reserve officials repeatedly hinted that rate cuts are imminent. Besides the notably dovish Chairman Powell, other officials either supported the idea that the economic environment does not require tightening or explicitly stated how rate cuts should be implemented.

Philadelphia Fed President Harker repeatedly mentioned on Thursday and Friday that rate cuts should be "orderly"; Chicago Fed President Goolsbee stated that the Federal Reserve should not only combat inflation but also focus more on employment; monetary policy is already quite tight, and the economy is not overheating, so there is no need for further tightening; Atlanta Fed President Bostic said that action should not wait until inflation fully drops to 2%, and there may be more than one rate cut this year.

02 New Federal Reserve Communications Agency "Proclaims Powell's Shift, Suggests Open Door for Larger Rate Cuts"

Federal Reserve Chairman Powell fully embraced his dovish attributes at this year's Jackson Hole Central Bank Annual Meeting, according to Nick Timiraos, a senior reporter and spokesperson for the Federal Reserve, known as the "New Federal Reserve Communications Agency."

On the morning of August 23, Eastern Time, after Powell's speech, Timiraos posted on social media platform X, commenting:

"Powell has completed the policy shift. Two years ago, Powell hinted that the Federal Reserve would accept an economic recession in exchange for normalizing inflation. Now, his stance has shifted to a comprehensive dovish one."

Timiraos then listed the following sentences from Powell's speech to demonstrate his dovish inclination, including:

"The cooling of labor market conditions is evident."

"The labor market is unlikely to become a source of rising inflationary pressures in the short term."

"We do not seek or welcome further cooling of labor market conditions."

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

"We will do everything possible to support a strong labor market while making further progress on price stability."

Wall Street Insights noted that although Timiraos did not publish a separate commentary on Powell's speech, his post on X included a link to a report he contributed to. This latest report pointed out that recently, some Federal Reserve officials have expressed their expectations for a series of 25 basis point rate cuts using relatively subtle phrases like "gradual" and "orderly."

Although Powell was persuasive in explaining the Federal Reserve's rate cut goals, he did not specify how to achieve this goal, completely avoiding terms like "gradual" and "orderly." By omitting such phrases, Powell has opened the door for larger rate cuts in the coming weeks if the labor market shows more severe signs of weakness.

The article also noted that compared to his remarks at the press conference following the Federal Reserve meeting at the end of July, Powell's statements this time were less ambiguous. At that time, he said the Federal Reserve needed more data to be confident that inflation was declining. His speech on Friday indicated that he now possesses that data.

In another post on X, Timiraos mentioned other impressive sentences from Powell's speech. Among them, when discussing the causes and behaviors of inflation since 2020, Powell recognized that not everyone would agree with his framework, summarizing, "This is my assessment of events. Your view may differ."

In the comments below this post, the most liked comment from a user read, "I’m glad it’s not an emergency rate cut."

03 America's "High Inflation Whistleblower": The Federal Reserve Has Recovered from Serious Inflation Errors but Misjudged Neutral Interest Rates

On Friday, former U.S. Treasury Secretary Summers, known as America's "high inflation whistleblower," stated that although the Federal Reserve failed to act swiftly to address the soaring inflation in the U.S. in 2021, marking a low point in its monetary policy history, it ultimately made sufficient efforts to correct the economy.

Summers said, "I must commend the Federal Reserve. While this is not always evident, they have taken sufficiently strong and proactive actions to maintain stable inflation expectations. We all make many mistakes. The important thing is to recognize and correct them when you make a mistake."

Shortly before Summers' remarks, Federal Reserve Chairman Powell announced that it is time to adjust policies, as consumer price increases have cooled, the upside risks of inflation have diminished, and the risks to employment have increased. Powell also acknowledged that the initial assessment in the spring of 2021 that inflation would be "transitory" was proven wrong later that year.

While Summers stated that it is the right approach for the Federal Reserve to prepare for a rate cut at the September meeting, he also believes that there needs to be more caution regarding the medium-term outlook for monetary policy.

Summers said he would be surprised if the Federal Reserve lowered rates to the level expected by the market, which is indicated by the derivatives market showing a benchmark rate of about 3% within the next two years. The current target range for the federal funds rate is 5.25%-5.5%.

When discussing the Federal Reserve policymakers' estimates of the long-term benchmark interest rate, Summers pointed out that the expectations of Federal Reserve officials are below 3%, which is still too low. Due to the large fiscal deficit in the U.S. and strong investments in green economy and advanced technologies, these factors exert upward pressure on borrowing costs, suggesting that the so-called neutral interest rate may be higher than in the past.

Summers bluntly stated, "I believe the Federal Reserve made a serious mistake in thinking that the neutral interest rate is so low, thus misjudging the restrictive nature of any established policy level. If you do not have the correct North Star, you cannot navigate accurately."