‘It is time for policy to adapt’

Federal Reserve Chairman Jerome Powell laid the groundwork for future rate cuts on Friday, although he declined to give exact indications on timing or size.

“The time has come for policy adjustment,” the central bank leader said in his highly anticipated keynote speech at the Fed’s annual retreat in Jackson Hole, Wyoming. “The direction is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.

Watch live: Fed Chairman Jerome Powell speaks from the Jackson Hole conference

While markets waited to see what direction monetary policy would take, Powell was equally focused on reviewing the root cause of the inflation that led to an aggressive series of 11 rate hikes from March 2022 through July 2023.

However, he noted progress on inflation and said the Fed can now turn its attention to the other side of its dual mandate, namely ensuring the economy remains near full employment.

“Inflation has fallen significantly. The labor market is no longer overheated and conditions are now less tight than before the pandemic,” Powell said. “Supply constraints have normalized. And the balance of risks for our two mandates has changed.”

He pledged that “we will do everything we can” to ensure the labor market remains strong and progress on inflation continues.

Stock prices rose as Powell began speaking, while Treasury yields fell sharply. Traders maintained a 100% chance of a rate cut of at least a quarter of a percentage point in September and raised the odds of a possible half-point cut to about 1 in 3, according to CME Group’s FedWatch.

“This was a parting statement in which Chairman Powell essentially turned the page and said that the mission of targeting inflation over the last two years has been successful,” economist Paul McCulley, a former Pimco executive, said on CNBC’s “Squawk on the street.”

The speech is accompanied by inflation continuing to push back toward the Fed’s 2% target, but it’s still not there. One of the Fed’s favorite metrics of late showed inflation at 2.5%, down from 3.2% a year ago and well above the June 2022 peak of above 7%.

At the same time, the unemployment rate has slowly but consistently climbed higher, most recently at 4.3%, in an area that would otherwise trigger a proven indicator of a recession. However, Powell attributed the rise in unemployment to more people entering the labor market and slower hiring, rather than to a rise in layoffs or a general deterioration in the labor market.

“Our goal has been to restore price stability while maintaining a strong labor market, while avoiding the sharp increases in unemployment that characterized previous periods of disinflation when inflation expectations were less well anchored,” he said. “While the task is not yet complete, we have made significant progress toward that outcome.”

Markets expect the Fed to start cutting in September, although Powell made no mention of when he thinks policy easing will begin. Minutes from the July open market committee meeting, released Wednesday, note that a “vast majority” of officials believe a September cut will be appropriate as long as there are no surprises on the numbers front.

“He’s pretty dovish. He bought the option to do what he has to do next month, which is obviously a convenience,” said Joseph LaVorgna, chief economist at SMBC Nikko Securities. ‘I don’t think the bar is set at fifty [basis points] is particularly high.”

In addition to assessing the current state of affairs, Powell also took considerable time in the speech to evaluate what led to the rise in inflation – which reached the highest level in more than 40 years – and the Fed’s policy response and why the price pressure has decreased without a recession occurring.

When inflation first started to rise in early 2021, he and his colleagues — as well as many Wall Street economists — dismissed it as “transitory” and caused by Covid-related factors that would subside.

“The good ship Transitory was crowded,” Powell joked to the audience with a laugh, “with most of the mainstream analysts and central bankers from the advanced economy on board. I think I see some former shipmates there today.”

As it became clear that inflation was spreading from goods to services, the Fed pivoted and started rising, eventually adding 5.25 percentage points to its benchmark rate, which had been near zero after emergency cuts in the early days of the pandemic.

The rise in inflation, Powell said, was “a global phenomenon,” the result of “rapid increases in demand for goods, strained supply chains, tight labor markets and sharp increases in commodity prices.”

He attributed confidence in the Fed and well-anchored expectations that inflation would eventually decline to the economy avoiding a sharp downturn during the rate hike cycle.

“The FOMC did not shy away from meeting our responsibilities, and our actions strongly demonstrated our commitment to restoring price stability,” he said. “An important lesson from recent experience is that anchored inflation expectations, reinforced by strong central bank actions, can facilitate disinflation without the need for slack.”

Powell added that there is still “a lot to learn” from the experience.

‘That is my assessment of events. Your mileage may vary,” he said.

Correction: The Fed raised rates eleven times between March 2022 and July 2023. In an earlier version, this figure was displayed incorrectly.