US Federal Reserve Chairman Jerome Powell signalled a possible interest rate cut in September in Jackson Hole. The markets reacted immediately with price gains – but there is more to his words than pure monetary policy. The Fed is caught between inflation risks, a weaker labour market and growing political pressure.
Markets react immediately
US Federal Reserve Chairman Jerome Powell paved the way for a key interest rate cut in September last Friday. The financial markets reacted with rises in share, bond and gold prices and a weakening of the US dollar against the euro. Normally, this would not be particularly noteworthy news. However, the considerable political pressure exerted on the Federal Reserve by the US administration has focused attention on how Powell would respond.
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“Adjustment” instead of “cut”
How does it sound when the world’s most important central banker signals an interest rate cut? ‘Given the restrictive policy stance, evolving risks may warrant an adjustment to our monetary policy stance.’ What this means is that the rise in inflation triggered by tariff increases is likely to be temporary, while the risks to the labour market have increased. A cynical view would also emphasise the dangers to the Fed’s independence. From an analytical perspective, one could argue that Powell spoke of an ‘adjustment’ rather than a ‘cut’. In context, however, it is clear that he meant an interest rate cut.
Difficult environment for the Fed
The environment for the central bank remains challenging: on the one hand, there are inflation risks, and on the other, the US government is calling for significant interest rate cuts and is even proposing changes to the Federal Reserve Act. President Trump recently threatened to dismiss Fed board member Lisa Cook if she did not resign.
Focus on employment
The Fed must now ensure price stability and full employment – while maintaining its independence. Powell resolved this balancing act by emphasising that the Open Market Committee’s decisions were, of course, data-driven. To signal an interest rate cut, he highlighted the downside risks to employment.
Employment growth has fallen significantly recently, to an average of only 35,000 jobs over three months. It remains unclear whether this is due to lower demand for labour or a decline in the labour supply. In the first case, interest rate cuts would be justified, but not in the second, as stimulated demand combined with a decline in supply could fuel wage inflation.
Inflation outlook
The Fed also points to uncertainties in the inflation outlook. The effects of the tariff increases are visible, but likely to be temporary. Accordingly, the baseline scenario assumes only temporary price increases.
Positive market reaction
The positive side currently prevails in the markets: the transition from a restrictive (hawkish) to a more growth-friendly (dovish) central bank is supporting risky asset classes. The purchasing managers’ index for August also rose to 55.4 points, signalling robust growth. Equities, bonds and gold benefited – and the weakening of the US dollar is also consistent with this.
Conclusion
The signal of a possible Fed interest rate cut is positive for the financial markets in the short term because the reasoning behind it (still) seems plausible from a market perspective.
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