Jackson Hole: 25 or 50?

The title of this year’s Jackson Hole Economic Symposium – essentially a short holiday camp for the world’s economists and central bankers – is “Reassessing the effectiveness and transmission of monetary policy”, an important question given the remarkable resilience developed market economies have shown to the sharpest interest rate hiking cycle we have seen in four decades.

The highlight of the two-day event is a speech from the chairman of the US Federal Reserve, Jerome Powell, on Friday (10am ET/3pm UK). The market will of course be scouring Powell’s words for any indication of his thinking after the sell-off and subsequent recovery sparked by labour market data earlier this month, and what it might mean for the impending rate decision at the Fed’s September 17-18 policy meeting. Given the futures market is currently pricing in around 95bp of cuts by year-end, and there are only three Fed meetings in that period, the most pressing question for investors is whether the Fed could start its cutting cycle next month with a 25bp or 50bp cut.

The conundrum for the Fed chiefly revolves around unemployment. The data earlier this month showed US unemployment had risen to a weaker than expected 4.3%, 0.9% off the lows of the cycle and enough to trigger the so-called Sahm Rule. While the recent uptick in unemployment is certainly a source of concern for the Fed, it will take some comfort from the fact that recent weakening has not just been a function of weaker labour demand (vacancy and hiring rates have come down but not steeply) but also stronger labour supply, given the highest prime-age participation rate since 2001 and high levels of immigration. In addition, data beyond the labour market remains resilient. The ISM services index showed a strong rebound in July after a soft June report, with the employment component in particular beating expectations. Retail sales figures beat expectations again last week, with the control group (which goes into GDP estimates) at 0.3% after a strong 0.9% print the month prior.

The Fed-speak we have had since the unemployment data has generally been measured, as you might expect. Clearly there remains a hawkish inflation bias for some members, with Mary Daly, Raphael Bostic and Jeff Schmid all focusing on inflation rather than labour data in recent comments. The Fed will not want to do anything to restoke inflation fears, particularly with Core PCE (the Fed’s preferred measure) hovering above its 2% target. But with inflation largely behaving itself (last week’s Core CPI data showed 0.165% month-on-month for July, taking the three-month annualised rate to 2%) the Fed won’t want to restrict the economy any more than it has to either, with rates still sitting at 5.5%. Powell called the Sahm Rule a “statistical regularity” rather than a signal for recession at last month’s policy meeting, but the Fed will be cognisant of the fact that once the unemployment rate starts to rise, it can be quite difficult to stop.

In our view, the data so far points to an economy that is slowing but still growing, and we expect Powell to highlight as much on Friday. We don’t think he is going to rule out a 50bp cut, especially given another labour report is due before the September meeting, and our base case remains for a 25bp cut.

With Fed officials not changing their tone since the weak non-farm payrolls data that sparked the sell-off, there is a possibility that the price action continues to backpedal closer to levels prevalent in mid-late July. The S&P 500 equity index has erased its losses month-to-date, and credit spreads have almost done the same. Government bond yields however remain near their lows for the month, so either Powell will validate this more bearish view or government bonds are set to give up some of the gains made over the past few weeks.