Powell treads fine line between fighting inflation and pivoting to rate cuts
Even so, he may still not be able to save the US economy from stagflation, the stock market from its recent wobbles, or his own job from the wrath of President Donald Trump
US FEDERAL Reserve chairman Jerome Powell had to perform a difficult turn on a tightrope at the central bank’s annual gathering in the Rocky Mountains over the weekend, and analysts were mostly in agreement that he pulled it off with aplomb.
Even so, Powell may still not be able to save the US economy from stagflation, the stock market from its recent wobbles, or his own job from the wrath of President Donald Trump.
In his keynote speech at the symposium of central bankers in Wyoming, which wrapped up on Saturday (Aug 23), Powell pivoted to interest rate cuts without giving any indication that he was bowing to Trump’s months-long pressure campaign.
Powell nimbly led his audience through the complex but compelling logic of cutting rates at a time when inflation was still rising, and jobs growth was not slowing that much.
“He walked a fine line, demonstrating the balance of risks, and delivering exactly what the market wanted,” said Michael Arone, the chief investment strategist at money manager State Street Global Advisors.
This latest conference in the wilderness dates back nearly 50 years to the days of then Fed chief Paul Volcker, but Powell’s speech may well have been the most momentous in its history.
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Ever since the Fed stopped cutting rates late last year, Powell and other central bankers have pointed to a quandary that had forced them to keep their benchmark rates at a still-elevated level.
Since January, the Trump administration has been reinventing the global trading order, dramatically hiking tariffs on friends and enemies alike.
What’s more, the administration was doing so in such an improvisational fashion that no one – be they importers, exporters, retailers and possibly even Trump himself – quite knows where import costs will eventually end up.
Everyone realised, of course, that these tariffs would increase prices for American corporations and/or consumers, but nobody knew to what extent.
And this reinvention of the global trading order was happening after a half-decade of extreme inflationary pressure that most economists expected to eventually slow the US jobs market.
Shifting its emphasis
All year, Powell’s position was that the responsible thing for the Fed to do was to keep the emphasis on its inflation fight until such time as the impact of tariffs on consumer prices became clear.
Only then could the Fed shift its emphasis to defending the jobs market, which it traditionally does by cutting interest rates. This tacit refusal to endorse the trade policy had led to Trump repeatedly calling for Powell to resign.
At Jackson Hole, Powell indicated that conditions were at last ripe for a rate cut, ending an eight-month wait for stock- and bond-market bulls. The clouds of uncertainty created by the nebulous reinvention of global trade had cleared, he said, and the decline of the jobs market was becoming more evident.
Powell described a US labour market that was showing classic signs of weakness, even though the headline job statistics were relatively stable.
He noted the particularly marked deterioration in July data. He explained that the reasons official jobs data was still pointing to resilience in the labour market were not particularly positive or sustainable. There were relatively few people looking for new jobs, he suggested, but there were even fewer new jobs for them to look for.
“Demographics, artificial intelligence (AI), productivity and immigration policy are all really having a (negative) impact on the labour market,” said Arone.
Powell made clear that the next phase for the labour market was most likely recessionary rather than a rebound.
He was certainly not sounding the all-clear on inflation. Uncertainty around tariffs had lifted, he said, because recent wholesale and consumer price data indicated the tariffs are certainly inflationary.
Rather, Powell said, the clear weakness of the jobs data had given the board confidence that inflation cannot stick. In his view, it was the likely fleeting nature of tariff inflation that made this the right moment to pivot.
Peter Graf, chief investment officer at Nikko Asset Management (Americas), said: “With no knock-on effect on wages, tariffs can be seen as a one-off price adjustment that does not interfere with the Fed’s stable inflation mandate, opening the door for rate cuts this fall.”
Predictably, the pivot caused a surge in stocks last Friday. The Dow Jones Industrial Average soared by roughly 900 points, one of the biggest gains in recent years.
Notably, the Magnificent Seven – the mega-cap tech companies leading the AI revolution – failed to recoup losses from a wobble earlier in the week. Investors still seemed to behave as though the AI boom had become an AI bubble and could become an AI bust.
There are two reasons why the long-awaited pivot may not be the panacea that the bulls had hoped for. The inflation caused by tariffs may not be fleeting, despite the Fed’s newfound confidence in its temporary nature.
Powell had once famously predicted that pandemic-era inflation would be “transitory” before finally accepting it was a long-term problem. Even as he suggested a rate cut was coming at the next meeting, he seemed to remain in “wait-and-see” mode on inflation.
“Risks lean towards September being the only cut for this year,” said strategists at BNP Paribas.
There is a bigger risk, and one that could cause a major sell-off on the stock market in the coming weeks.
“The greater risk is that it’s a long way between now and the next Fed meeting, depending on how inflation and the labour market break,” said Arone. “If Powell walks back on his speech in Wyoming and decides not to cut interest rates, the market will react negatively to that.”
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