Jackson Hole Retreat

Powell's dovish turn at the Jackson Hole meeting came without warning, and some of his remarks contradicted statements made during the July FOMC press conference. In his review and outlook on the economy, Powell underwent a 180-degree shift in his views on the labor market, beginning to express clear concerns about the downside risks to employment.

This shift in reference points is very similar to the decision not to cut interest rates in July, and it is difficult to explain solely through changes in economic data; it perhaps demonstrates that Trump's political pressure on the Federal Reserve has finally yielded results.

Although the Federal Reserve has maintained its expectation of two rate cuts (50bp) in 2025, this clearly dovish signal strengthens not only the possibility of a 25bp rate cut in September but also the likelihood of consecutive rate cuts within the year.

Powell's speech at the Jackson Hole meeting was divided into two parts: the first part was a review and outlook on the economy, and the second part was about modifications to the Federal Reserve's monetary policy framework. At the very beginning of the speech, Powell bluntly stated that "the balance of risks appears to be shifting," which set a dovish tone for the entire address.

I. Powell's "Jackson Hole" Retreat

Powell summarized the labor market as being "in a peculiar balance of weak supply and demand," and more critically, that "downside risks to employment are rising. And if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment."

It is particularly noteworthy that the use of the word "sharply" to indicate labor market risks is rare and is often only used during significant economic shocks (such as the Russia-Ukraine conflict or the 2020-2021 supply chain disruptions).

When this statement comes from the mouth of the Federal Reserve Chairman, we naturally worry whether Powell has seen some labor market deterioration data that we have not noticed: for example, a turning point in the reduction of labor supply or signs of a collapse in labor demand.

Unlike the July FOMC meeting, where he emphasized that the only labor market indicator he was focused on was the unemployment rate, at this Jackson Hole meeting, Powell chose to focus on the "weak" aspects of labor data, such as the sharp slowdown in labor growth and the continued decline in labor participation rates.

The dovish signals sent by Powell indicate that his concerns about the "two-stage" decline in private sector employment (i.e., zero growth or even negative growth in private sector employment) are beginning to materialize. It is worth noting that the deterioration of these data did not occur overnight, and Powell's deliberate selection cannot be explained solely by economic factors. Interest rate cuts are a complex game between economics and politics.

Powell has leaned towards the "Waller faction" regarding inflation, meaning he is starting to view tariffs as a temporary one-time shock (the effects will be relatively short-lived—a one-time shift in the price level).

Specifically, Powell still described three paths: one-time inflation, wage-inflation spiral, and unanchored inflation expectations. His description of one-time inflation is not significantly different from previous FOMC meetings; what Powell emphasizes is actually the denial of the other two scenarios: given that the labor market is not particularly tight and faces increasing downside risks, a wage-inflation spiral seems unlikely; meanwhile, long-term inflation expectations have not changed significantly.

Powell chose to align with the market, believing that as long as tariff inflation does not accelerate significantly, this is a "good report"; in some ways, this is fundamentally similar to the assessment of temporary inflation in 2021.

Based on this, Powell still summarizes the current economic situation as upward inflation risks and downward employment risks, but the conclusion has changed: it is no longer a wait-and-see approach as in the July FOMC, but rather that the current situation meets the conditions for adjusting monetary policy (the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance).

Overall, from the July 30 FOMC to the August 22 Jackson Hole meeting, the slight increase in the unemployment rate but significant downward revision of employment numbers in the non-farm report, along with two relatively hot price reports, have significantly reversed Powell's attitude towards interest rate cuts, which previously focused solely on the unemployment rate without regard for new employment and was highly concerned about inflation risks.

II. Modifying the Monetary Policy Framework, Tolerating Policy Fluctuations

The second part regarding the modification of the monetary framework essentially returns to the 2012 version, removing the description of the zero lower bound (Zero Lower Bound). The "average inflation targeting" introduced in 2020 has long been a mere formality. This modification re-emphasizes the dual balance of inflation and employment (a balanced approach), but the details show a more pronounced dovish tendency In terms of the price stability target, it has completely abandoned the modifications made in 2020 and returned to the original framework introduced by Bernanke in 2012, based on a flexible inflation targeting system with a 2% inflation target. This is essentially more ambiguous, and the Federal Reserve's ultimate interpretation has greater flexibility.

The framework for full employment reflects asymmetry, suggesting a preference for "economic overheating rather than economic stagnation."

The Federal Reserve believes that the previous definition of employment shortfall was not clear enough, and that in many cases, an overheated labor market is not the source of inflation. Therefore, it has been revised to state that "the Committee recognizes that employment may at times run above real-time assessments of maximum employment without necessarily creating risks to price stability."

This means that, in the absence of other shocks (such as tariffs, supply chain issues, etc.), an overheated labor market does not necessarily face monetary policy tightening: the main reason is the uncertainty in measuring the natural unemployment rate, so in the short term, wages may not necessarily become a source of inflation. Thus, under this framework, the U.S. economy is more likely to see accelerated economic growth, sustained overheating in the labor market, and a lagged but noticeable feedback on inflation.

We understand this more as a super-sized version of the Federal Reserve's put option (FED Put), which indicates excessive tolerance for full employment. Economic growth leads employment, and employment leads inflation. Under the new framework, this tolerance for employment is likely to result in significant fluctuations in monetary policy, with the intervals between rate cuts and hikes becoming increasingly shorter; the volatility of monetary policy will be amplified, and forward guidance may gradually give way to data dependence.

III. Future Path of Rate Cuts and Asset Impact

The threshold for "not cutting rates" in September has become higher, primarily depending on non-farm payroll data. If the August non-farm payroll data does not show a comprehensive improvement, there is a possibility that the Federal Reserve may ignore inflation data and implement a 50bp compensatory rate cut. An increase in inflation levels (slightly exceeding expectations) is unlikely to trigger concern, as it can be characterized as a one-time shock, with some "aftershocks" being acceptable.

At the same time, considering that Trump's interference with the Federal Reserve Board is further increasing, his relentless pursuit of Governor Cook and the clear factionalization of the Federal Reserve Board will bring greater political pressure. This suggests that we are likely to see consecutive rate cuts within the year, with the benchmark rate cut likely to be adjusted to 75bp.

For the US dollar, the landing of the interest rate cut does not necessarily lead to a continuation of the downward trend. The Federal Reserve's actual actions (interest rate cuts) and future policy expectations (a more dovish monetary policy framework) may further improve expectations for the US economy. Coupled with the gradual resolution of tough issues in tariff agreements between the US and Europe, as well as between the US, Canada, and Mexico, the relative pressure for future economic growth may gradually shift towards non-US countries.

Before the midterm elections, Trump's comprehensive control over various sectors of the US economy will further enhance the attractiveness of US assets.

Currently, there is still an investment boom primarily focused on AI or the broader technology category. Before the fundamental economic conditions in various countries show significant improvement, whether funds flow out of US stocks needs to weigh not just simple interest rate differentials, but the actual returns of assets in various countries. The trend of the US dollar is also not solely about interest rate differentials, but rather a "probability bet" on technological breakthroughs.

Following this path, it is foreseeable that interest rate cuts will support economic growth (especially consumption, which is more closely related to short-term interest rates) and will underpin actual interest rate levels. The selective neglect of inflation issues will also prompt bond investors to demand higher inflation compensation.

From a risk perspective, the expected decline in long-term US Treasury yields may be eroded by term premiums: the deficits, credit, and liquidity issues implied by term premiums can only be alleviated but not completely resolved; the independence of the Federal Reserve may also be more prominently reflected in pricing.

Considering Trump's control over fiscal and monetary policy, the steepening of US Treasury yields may trigger the Federal Reserve to stop balance sheet reduction or even expand the balance sheet, or adopt some form of ambiguous yield curve control (YCC) to lower long-term interest rates. In short, short-duration bonds have greater certainty, medium-duration bonds seek larger capital gains, while long-duration bonds require Trump to "take action."

High long-term interest rates will continue to suppress the recovery of interest rate-sensitive sectors. Over the past decade, Florida and Texas have jointly contributed 32% of manufacturing job growth and 25% of manufacturing business growth, with swing states also making significant contributions.

This has become one of Trump's key issues in the midterm elections, namely significantly reducing financing costs for the US real sector. This not only counters the impact of the OBBB Act's "no free riders" on the base of red states but also seeks support from more Rust Belt and swing state voters; pushing for lower mortgage and commercial loan interest rates will become Trump's next demand.

Finally, we want to remind you that the side effects of a relatively loose monetary policy environment and a dovish policy framework cannot be ignored: the future will face more difficult-to-control inflation dynamics. After significant interest rate cuts, a re-accelerating US economy will inevitably face a higher inflation center; this year will be more "stagnant," and next year will be more "inflated." To address the issue of "inflation," the US must continue its bet on AI technology significantly enhancing production efficiency, which is, to some extent, also a matter of national will for the United States Risk Warning

The uncertainty of Trump's policies has increased, leading to more significant turbulence in the financial markets and a faster outflow of overseas funds from the dollar; the global economy is more affected under increasingly clear tariffs, with global synchronized easing in the second half of the year exceeding expectations, potentially leading to a global resonance in balance sheet expansion, significantly alleviating long-term interest rate pressures; technological breakthroughs are intensifying the return of manufacturing, with a noticeable reduction in production costs in the United States and a surge in credit demand.

Risk Warning and Disclaimer

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