Powell’s Jackson Hole Pivot: Signaling Rate Cuts amid Rising Downside Risks to Employment

Fed Chair Jerome Powell’s comments at Jackson Hole shifts the outlook for interest rates.

KEY POINTS

What it is

Powell signaled a shift toward rate cuts to counter rising job risks while balancing inflation and potential economic slowdown.

Why it matters

A shift toward a rate cut in September may reduce the probability of adverse U.S. economic outcomes.

Where it's going

The path forward is likely to be narrow, uncertain, and — above all — data-dependent.

Federal Reserve Chair Jerome Powell’s remarks at the Jackson Hole symposium on Friday delivered a subtle but unmistakable shift in tone on the near-term direction of U.S. monetary policy. He acknowledged that the July employment report showed a slowing in job growth that was “much larger than assessed just a month ago” and that downside risks to employment “are rising”. More tellingly, while also acknowledging that risks to inflation remain “tilted to the upside”, he noted that “the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance”.

Markets, always hyper-attuned to the faintest shifts in the wind, have swiftly recalibrated. A 25-basis-point rate cut at the September Federal Open Market Committee (FOMC) meeting is now our base case, and the pricing is explicit: futures markets have embedded this expectation with conviction. The FOMC’s restrictive policy stance, long justified by sticky inflation, is now being challenged by the prospect of rising unemployment.

Importantly, Powell’s pivot should also be viewed as a strategic move to mitigate the tail-risk of a hard landing. By shifting toward an easing stance, the Fed is not only addressing emerging employment threats but also lowering the probability of more adverse outcomes for U.S. economic activity — providing a backstop that reassures financial markets.

Recent economic data only reinforces the plausibility of this scenario. Over the past several weeks, the hard and soft indicators alike have painted a picture consistent with the oft-cited “soft landing”. Growth is cooling but not collapsing, demand is slowing in a controlled fashion, and inflation has retreated from the multi-decade highs that so alarmed policymakers last year. If ever there was a window to transition toward a more balanced monetary stance, it is opening now.

Of course, the Fed’s next moves will be shaped not only by its own evolving assessments of the outlook and attendant risks, which will in turn be informed by the inflation and economic activity data to arrive before the September meeting. Should the data surprise to the upside — strong hiring, resilient wage growth, or a re-acceleration in inflation — the Fed may opt for what the market has already begun to coin a “hawkish cut,” or even not cut at all in September. Regarding the former, it is entirely plausible that the Fed cuts rates while signaling that the easing cycle will be shallow — a mere recalibration, rather than a wholesale shift toward accommodation.

The ramifications for long-dated interest rates could be profound. A hawkish cut, far from fueling a rally in Treasurys, could spark concerns that policy will remain restrictive for longer, pushing up yields at the long-end of the curve. In turn, this could paradoxically tighten overall financial conditions even as the Fed attempts to loosen them — an outcome that would frustrate the central bank’s aims and potentially amplify the very downside risks to employment Powell is now acknowledging.

It’s crucial to note that the Fed’s pivot does not stand in isolation. Across the globe, central banks from Europe to Asia have embarked on their own campaigns of rate cuts, collectively contributing to more accommodative financial conditions around the globe. This synchronized easing amplifies the broader impact, offering tailwinds to both global growth and risk assets. The Fed, then, is very much a participant in a worldwide shift — a recognition that the challenge of reigniting economic vitality transcends any single economy’s borders.

With the Fed’s shift aligning ever closer to the global easing trend, narrowing interest rate differentials — particularly in the context of still above-average inflation — are poised to exert additional downward pressure on the U.S. dollar. This environment sets a favorable stage for non-U.S.-dollar risk assets to continue outperforming.

As we look ahead to the September meeting, the message is clear: The Fed’s balancing act has become more challenging as policymakers are facing rising downside risks to employment while still seeing upside risks to inflation. Market participants would do well to resist the temptation to interpret every move as a harbinger of full-blown easing. The path forward is likely to be narrow, uncertain, and — above all — data-dependent.

Meet Your Expert

Peter Wilke

Senior Vice President – Head of Tactical Asset Allocation

As the head of tactical asset allocation (TAA) at Northern Trust Asset Management, Peter is responsible for the research and development of innovative investment strategies for the firm’s TAA initiatives.

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