🤔 The market's dovish interpretation of Powell's speech may be somewhat excessive.

Written by: Li Xiaoyin, Wall Street Insights

Last Friday, Federal Reserve Chairman Powell's speech at the Jackson Hole Global Central Bank Annual Meeting was widely interpreted as a clear signal for a rate cut in September, instantly igniting market enthusiasm and pushing U.S. stocks to new historical highs.

However, American economist and Stanford University President Jonathan Levin wrote in a Bloomberg column on Saturday that a deeper analysis of Powell's remarks at Jackson Hole reveals that the core message is not unconditional easing, but rather a difficult balancing act between the dual risks of a sluggish labor market and high inflation in a foggy economic environment.

Levin stated that the market's euphoric reaction on Friday largely overlooked the key subtleties in Powell's speech. He emphasized that if the Fed does indeed cut rates, it may be due to the economy facing troubles that necessitate intervention from the central bank, rather than a cooling of inflation. This significant context was drowned out by the market's initial response.

The article emphasizes that Powell admitted in his speech that decision-makers are facing a tricky task of balancing the dual mandate of promoting maximum employment and maintaining price stability. This policy dilemma suggests that the future path of rate cuts may be slower and more uncertain than the market expects.

Difficult Choices Under Dual Mandate

The article points out that when inflation soared to 9.1% in 2022, the Fed's goals were very clear, and policy consensus was relatively easy to achieve. However, the situation policymakers face now is much more complex.

Powell also emphasized in his speech:

"When our goals are in tension like this, our framework requires us to balance the two aspects of our dual mandate."

Levin explains that on one hand, although the unemployment rate is low, labor market data has begun to waver. On the other hand, inflation remains slightly above the Fed's 2% target.

The article cites Powell's remarks stating, "Our policy rate is now 100 basis points closer to neutral than it was a year ago," which allows the Fed to "proceed cautiously." However, he also warned that "monetary policy is not set on a predetermined path."

This policy divergence has already emerged within the Fed. The decision to maintain interest rates at 4.25% to 4.5% in July faced opposition from two board members, marking the first such occurrence since 1992, highlighting the significant differences in interpreting current economic data.

Downside Risks in the Labor Market

The article emphasizes that behind the market's cheers for a rate cut, a key point that has been overlooked is that the Fed's primary motivation for cutting rates may stem from concerns about economic deterioration.

In his speech on Friday, Powell specifically pointed out that the current labor market is in a "peculiar balance," where both labor supply and demand are significantly slowing, partly due to tightening immigration policies.

Powell stated candidly:

"This unusual situation indicates that the downside risks to employment are rising. If these risks materialize, they could quickly manifest in the form of a sharp increase in layoffs and rising unemployment rates."

In other words, a rate cut would be a defensive measure rather than a triumphant declaration of a strong economy.

The article notes that other data supports this concern. Powell mentioned that the U.S. GDP growth rate in the first half of this year was only about half of what it is expected to be in 2024, partly due to slowing consumer spending. This does not align with the foundation of the ongoing bull market.

The Inflation Dilemma Remains Unresolved

While there are concerns about the labor market, inflation risks still persist.

The article states that many economists continue to worry that the tariffs implemented during Trump's administration will drive up commodity prices in the coming months and even quarters. Although the current impact appears mild, industry insiders expect that the pressure for price increases will become evident when new car models are released in 2026.

How to respond to the price shocks caused by tariffs is itself a fiercely debated topic. Doves believe that policymakers should ignore these "one-time" price level changes; while hawks worry that, after enduring nearly five years of high inflation, this could exacerbate the loss of control over inflation expectations.

Levin believes that Powell himself seems to lean towards the camp that "ignores" the impact of tariffs, which may be one of the few dovish nuances in his speech. However, he also clearly warned, "We cannot take for granted that inflation expectations will remain stable," acknowledging concerns in this area.

Market Reaction May Be Excessive

The article concludes by emphasizing that the market's dovish interpretation of Powell's speech may be somewhat excessive, or it may be due to investors previously expecting a firmer stance, leading to position adjustments. The actual situation is much more subdued, but entirely appropriate for the current economic context.

Beyond the policy challenges, Powell's speech also cleverly sidestepped the political pressure from Trump to significantly cut rates. From any angle, Powell's remarks showed no signs of yielding to pressure.

Levin stated that based on the existing data, the Fed appears ready to cut rates as early as next month and subsequently explore appropriate interest rate levels to support sustainable growth and low inflation. However, the outlook remains highly uncertain, and the pace of policy easing may be slower than the market expects.

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