Jackson Hole Marks The Start Of The Rate Cut Era (DJI)

Introduction

Earlier today, Federal Reserve Chairman Jerome Powell highlighted the annual Jackson Hole economic symposium with some remarks. The address is typical practice of the Federal Reserve Chair and one of the most anticipated economic events of the year outside the FOMC meetings. Chair Powell signaled a rate cut was coming clearly by stating, “the time has come for policy to adjust.” Powell’s comments matched a growing wave of data suggesting that the Federal Reserve is about to cut interest rates, which I agree with, but investors need to proceed with caution when it comes to the future outlook.

A Wave of Weakening Jobs Data

Heading into Jackson Hole, several economic reports were released, suggesting that the Fed’s focus on inflation needed to pull back towards its dual mandate (inflation and unemployment). On Wednesday, the Bureau of Labor Statistics released its preliminary benchmark revision to the employment market for the twelve-month period ending March 2024. The report found that the economy had created 818,000 fewer jobs than originally expected. While other influential data like the size of the labor force is yet to be determined, such a large revision is almost certainly going to project the unemployment rate as being higher than previously thought.

The labor department’s report followed two consecutive months of weak job growth. The June report showed an unusual tick up in unemployment among educated workers, and the July report saw an overall increase in the unemployment rate that triggered the Sahm rule. As of the end of July, the unemployment rate had risen to 4.3%, which is higher than the Fed’s 2024 and 2025 economic projections, along with their long-term unemployment rate target. Today, Powell said, “we do not seek or welcome further cooling in labor market conditions.”

Inflation is Tapering But Still Present

The Federal Reserve began aggressively raising interest rates in 2022 after it became clear that inflation was more than transitory. The core personal consumer expenditure (Core PCE), which excludes food and energy, was well over 5% for an extended period. This was far higher than the Fed’s long-term inflation goal of 2%. While Core PCE did drop below 5% in early 2023, it took several months to see substantial progress, with core inflation falling below 3% earlier this year.

The inflation challenge going forward is complex for two reasons. First, over the next six months, five of the lowest monthly core inflation numbers will be rolling off. For core inflation on a year-over-year basis to hit 2% six months from now, investors would need to see a cumulative inflation rate of 0.3% or less. These objectives are possible, but difficult in an environment of declining rates.

Secondly, inflation is certainly not spread equitably across the economy. Currently, all the inflation being experienced in the economy is coming from the service sector, while goods inflation has either been near or below zero for several months now. Should interest rate cuts cause goods inflation to start back up, the services side will need to deflate further to compensate. Unlike overall PCE, the services side has some promise for moderating, as two of the larger monthly readings are set to roll off in the next three months.

Risks Remain

While investors can certainly expect a rate cut at the September meeting, the outlook beyond that is far less clear. As Powell stated today, “the timing and pace of rate cuts will depend on incoming data, evolving outlook, and the balance of risks.” The FOMC will be less inclined to cut rates further if inflation heats up in the months following cuts. On the other side, the Fed will be placed under greater pressure to cut rates further if the labor market deteriorates in the coming months. It is possible for both of these interests to place pressure on the Fed in the coming months. While the idea of stagflation seems preposterous to many, the risks of that dichotomy are rising.

The Next Meeting is About More Than the Cut

Investors will be hinging on the announcement of the rate cut and subsequent comments when the Fed announces monetary policy on September 18^th. Unfortunately, the big story will not lie in the statement, but in the new set of economic projections that the committee is expected to release. These projections will include, among other things, the pace of cuts that the Federal Reserve expects to implement for the next couple of years. Investors should not be surprised if the Federal Reserve raises its 2025 rate estimates in September, as it has it for over a year now.

Conclusion

Federal Reserve Chair Jerome Powell’s speech today marks the transition towards monetary policy easing, but multiple rate cuts are nowhere near guaranteed. Monthly core inflation over the next six months is going to need to come in at or below 0.1% for a notable push toward the 2% target. Elevated asset prices remain across the economy, and the popping of those bubbles could trigger a hard landing. These threats can easily undermine earnings and create volatility in equity markets. The Fed is about to walk a tightrope, and investors should remain vigilant regarding economic data to ensure their portfolios are well positioned.