The Strategist

Monetary policy outlook: a shift towards easing?

At the Kansas City Fed’s symposium in Jackson Hole, Federal Reserve Chair Jerome Powell signalled potential US interest rate cuts, citing a cooling labour market and easing inflation. Powell’s remarks highlight a shift towards a more flexible, "data-dependent" policy approach. With the Fed’s September meeting approaching, markets are keenly awaiting signals on the timing and extent of possible rate reductions by year-end.

Date
Author
Dr. Wolfgang von Hessling, Chief Economist EMEA
Reading time
10 minutes

Strategist Jackson Hole
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Powell’s recent remarks in Jackson Hole, Wyoming, strongly hinted at the possibility of first US interest rate cuts in the near future. Speaking about the evolving economic landscape, Powell acknowledged that "the time has come for policy to adjust", reinforcing expectations that the central bank could lower rates at its upcoming September meeting. He noted that the labour market slowdown is now "unmistakable", that the Fed does "not seek or welcome" further cooling and reiterated that inflation is increasingly on a "sustainable path" back towards the central bank’s 2% target.

Powell admits misjudgement regarding rise in prices

Powell’s speech also reflected on the Fed’s response to the surge in inflation in 2021-2022, admitting that initial assumptions that rise in prices would be transitory had been a misjudgement. This had led to the need for a rapid series of interest rate hikes that had pushed the policy rate up by five percentage points between spring 2022 and summer 2023. However, with inflation now below 3%, economic growth sluggish, and the labour market showing signs of strain, the current ultra-restrictive stance is increasingly seen as misaligned with broader economic conditions.

From today’s perspective, the Fed’s aggressive tightness appears excessive given the state of the US economy. While US economic headline GDP growth has remained surprisingly robust since the rate environment has turned ultra-restrictive, signs of economic cooling have become ubiquitous: despite the persistence of inflationary pressures earlier this year, recent data show a significant slowdown in both headline and core inflation measures. At the same time, hiring rates and wage pressures are easing, and unemployment claims are on the rise - indicators that point to a labour market that is beginning to feel the pain of prolonged high interest rates. Given these developments, there is a growing consensus that rate cuts may be necessary by year-end, with some predicting a reduction of up to one percentage point, bringing the policy rate down to around 4.5%. Powell highlighted the importance of maintaining flexibility in applying the lessons learned over recent years, emphasising that future decisions will be "data-dependent" and responsive to risks as they emerge. Still, with economic activity weakening and inflation risks now more balanced, many believe that the Fed’s stance is likely to pivot towards easing.

Fed sees ample room for manoeuvre, markets expect cuts

The critical question going forward is whether the Fed can successfully continue the balancing act of its dual mandate - returning inflation to 2% while preserving a strong labour market - without tipping the economy into recession. As Powell noted, the central bank’s current rate levels provide ample room for manoeuvring in response to these risks, especially if economic cooling deepens. All eyes will be on the Fed’s September meeting, where markets expect clearer signals about the timing and extent of any rate cuts going into year-end.
 

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