Yves here. While Fed Chair Jerome Powell did not descend to Greenspan levels of bafflegab, he said enough of what people wanted to hear, that a September rate cut might be in the works, while making all sorts of cautionary noises that that still might not happen.
And the real problem for Powell is that the US looks to be heading into stagflation. Even with stimulative fiscal deficits, the last plus revised two prior job reports were weak, but reported inflation is higher than what the Fed likes. And as readers vigorously point out, their personal inflation is much higher than what official data shows. And conditions are not likely to improve. Even though the largest retailers so far seem to be eating a fair bit of tariff costs, smaller fry don’t have the profits to do that, plus the big boy may be doing so as an intended placation of Trump, and will gradually start putting through tariff-related price hikes.
The Fed is not well positioned to remedy stagflation, absent the Volcker remedy of increasing rates so high as to nearly kill the economy stone cold dead. And even that might not work if cost increases are due in no small measure to resource scarcity and tariff-induced supply chain breakage.
By Wolf Richter, editor at Wolf Street. Originally published at Wolf Street
Powell’s speech today at the Jackson Hole conference had two major components: Short-term monetary policy and for the long term, the Fed’s new monetary policy framework.
Monetary Policy: “Shifting Balance of Risks May Warrant Adjusting Our Policy Stance,” but “Carefully.”
Powell made room for a rate cut in September, as “the balance of risks appears to be shifting” to concerns about the labor market.
But it was tempered with lots of concerns about inflation, including his projection that the 12-month core PCE price index for July, to be released in a week, would accelerate further to 2.9%.
Cutting rates as inflation is accelerating is a delicate affair that could spook the bond market and drive up long-term rates – which is precisely what happened in 2024 when the Fed cut by 100 basis points and long-term yields rose by over 100 basis points.
So Powell laid out a scenario of “carefully” nudging down the policy rate, rather than an aggressive series of rate cuts. He said:
“In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside—a challenging situation. When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate.
“Our policy rate is now 100 basis points closer to neutral than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance.
“Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.”
This “may warrant adjusting our policy stance” was all the market wanted to hear. The text of the speech was released before Powell read it at the conference, and the trading algos reacted to the text instantly, and even before Powell started speaking, stocks jumped and the 10-year yield dropped.
He acknowledged the difficulties for the Fed posed by the mix of weakening labor-market growth and rising inflation.
Part of the labor market equation is the lower supply of labor due to immigration policies. So, “it does not appear that the slowdown in job growth has opened up a large margin of slack in the labor market,” Powell said. This slack in the labor market would show up in higher unemployment rates, for example, but the unemployment rate has remained “historically low” (between 4.0% and 4.2% since May 2024).
He said:
“Labor supply has softened in line with demand, sharply lowering the ‘breakeven’ rate of job creation needed to hold the unemployment rate constant.”
“It is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers. This unusual situation suggests 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.”
But then there was some heavy breathing about inflation:
“It is also possible, however, that the upward pressure on prices from tariffs could spur a more lasting inflation dynamic, and that is a risk to be assessed and managed.”
“One possibility is that workers, who see their real incomes decline because of higher prices, demand and get higher wages from employers, setting off adverse wage–price dynamics. Given that the labor market is not particularly tight and faces increasing downside risks, that outcome does not seem likely.”
“Another possibility is that inflation expectations could move up, dragging actual inflation with them. Inflation has been above our target for more than four years and remains a prominent concern for households and businesses.”
“Come what may, we will not allow a one-time increase in the price level to become an ongoing inflation problem.”
Monetary Policy Framework: “Average iInflation” Targeting Is Dead
Over the past months, the Fed conducted an internal review of its monetary policy “framework,” as it vowed to do every five years. This framework is a set of guidelines for the FOMC’s monetary policy decisions. Today, Powell introduced the resulting new “2025 Statement on Longer-Run Goals and Monetary Policy Strategy” that was passed unanimously by the FOMC.
The most important change in the new framework is the elimination of “average inflation” targeting, an odious strategy created in the framework of August 2020, which specified that the Fed would allow inflation to “run moderately above its 2% target” to make up for periods when it ran below the 2% target, to achieve an inflation rate that “averages 2% over time.”
The result of that “average inflation” targeting guideline of August 2020 was the inflation shock.
Inflation began raging at the beginning of 2021, but the Fed continued its near-0% policy and massive QE into early 2022. The Fed didn’t react to raging inflation for 15 months. I called it “the most reckless Fed ever” (google it).
By the time the Fed hiked for the first time in March 2022, bringing its policy rates to 0.25%-0.5%, CPI inflation was already at 8.5%. This was responsible, among other things, for the explosion of home prices (roughly 50% in less than three years), as the Fed’s massive QE, including the purchase of trillions of dollars of MBS, pushed down mortgage rates below 3%, while CPI inflation eventually exceeded 9%. This was the best free money ever. And when money is free, prices no longer matter.
This refusal for 15 months to end these crazed monetary policies of massive QE and near-0% policy rates in face of raging inflation was at least in part brought about by the Fed’s newfangled “average inflation” targeting guideline established in 2020.
In today’s framework, the Fed killed this odious concept of “average inflation” targeting and returned the framework to the previous method of inflation targeting.
Powell said:
“Our revised statement emphasizes our commitment to act forcefully to ensure that longer-term inflation expectations remain well anchored, to the benefit of both sides of our dual mandate.
“It also notes that ‘price stability is essential for a sound and stable economy and supports the well-being of all Americans.’ This theme came through loud and clear at our Fed Listens events. The past five years have been a painful reminder of the hardship that high inflation imposes, especially on those least able to meet the higher costs of necessities.”
Lesson learned.
The 2% target itself remained etched in stone and wasn’t even on the table for the discussions of the new framework, as Powell had said all year during his numerous post-meeting press conferences.
