Despite all the negative headlines, I don’t think the speech is as bad as what the media paints it to be at first. Most headlines are screaming only at what Jerome Powell says in the first part of his speech about higher rates might be needed. But if you parse everything he says, it is nothing more than a further affirmation of what was released in the prior minutes. Many market participants would already have been prepared for this.
Key Points In His Jackson Hole Speech
If I were to summarize the main points in the speech. It would be as follows:
1️⃣ The US economy is not slowing as fast as the Fed wants it to. Strength in consumer spending, hiring, and wage growth presents risks to inflation. That means we cannot rule out the need for further hikes or for the rates to remain higher for a longer period of time.
2️⃣ Core PCE inflation is what the Fed focuses on and it’s still too high. The last print was 4.1%. And Fed’s target is to bring the Core PCE inflation back down to 2%. This target remains unchanged despite calls from various market participants to revise it upwards in the name of changing norms.
3️⃣ He acknowledged that inflation showed signs of slowing and that the full effects of the rate hikes have yet to kick in, but will need to see more progress on that.
4️⃣ As usual, he said the Fed is aware of the risks that raising rates unnecessarily might tilt the economy into a recession, but he would have to balance it against the risks of allowing inflation to become more entrenched.
Fed Funds Rate Expectations Moved Up After The Speech
After the speech, the Fed Funds Futures market is pricing in a 57.5% probability of another rate hike in November. As compared to a week ago, the Fed Funds rates expectations have lifted across the board as the additional hike gets priced in. But in terms of trajectory, it remains largely unchanged. The market sees the Fed easing sometime in mid-2024 with Fed Fund coming down to around 4.5% at the end of next year. Of course, between now and then, plenty of changes can take place.
Fed Funds Rate Expectations (source: https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html)
What is Next?
Now, what follows will hinge a lot on the inflation numbers more than other economic data. Core PCE (July) will be due next week. The forecast for YoY is 4.2% and MoM is 0.2%. But with CPI numbers for July already released earlier in the month, I doubt there will be much of an element of surprise even though they are constituted using slightly different baskets and methodologies. If subsequent numbers keep coming in lower than what economists and markets anticipate, then I think there is a pretty good chance the last hike is behind us.
But having said that, labor, wage growth, GDP, commodity prices, and market expectations would all have an impact on the Fed’s decision. Unless these also show a sustained slowdown, particularly if inflation isn’t budging much, if not, there is always the risk of inflation stalling or resurging. So I think it is understandable that the Fed can’t afford to let go by sounding less hawkish and boosting optimism at a time when they want to see the economy slowing more for assurance. But everywhere else is slowing and only the US is bucking the trend now. So perhaps the rate hike effects not coming through yet, things may shift eventually.
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