On Friday, August 23rd at 10 AM Eastern Time, Federal Reserve Chairman Powell made a significant statement at the Jackson Hole Global Central Bank Annual Meeting.

It is worth noting that Powell was quite explicit and stated, "The time for policy adjustments has come. The policy direction has been clarified, and the timing and pace of rate cuts will depend on subsequent data, changing prospects, and risk balance."

Some analysts have noted that although Powell confirmed the market's widespread expectation of rate cuts in September and his speech was considered dovish, providing some clarity to the financial markets in the short term, it did not provide many clues about how the Federal Reserve will act after the September meeting.

For example, if there is another negative jobs report, will there be a significant 50 basis point cut? And will there be continued rate cuts in the coming months? However, Powell's remarks at least confirm that the Federal Reserve's struggle with inflation over the past two years is approaching a key turning point.

After finishing his prepared remarks, Powell did not have a live Q&A session, and the market's expectations for the total amount of rate cuts by the end of 2024 remained unchanged at around 98 basis points. The probability of a 25 basis point rate cut in September also remained stable.

In the market's reaction, stock indices continued to rise, with the S&P 500 increasing more than 1% in the first hour of trading. The Dow Jones Industrial Average briefly rose by 400 points, while the tech-heavy Nasdaq and the more economically sensitive Russell small-cap stocks were leading, rising by 1.5% and 2% respectively. The regional banking index in the US stock market rose by 5%, marking the largest increase in eight months. Bond yields and the US dollar index both experienced short-term declines, which are related to the logic of trading on the expectation of a rate cut by the Federal Reserve.

Powell said that he is increasingly confident that inflation will continue to decrease to the target, and specifically pointed out that rate cuts are the future policy direction.

The economic symposium attended by Powell is titled "Reassessing the effectiveness and transmission of monetary policy," and his speech not only reviews the balance between the two major missions of the Federal Reserve after the epidemic, namely "employment and prices," but also clarifies how the future policy direction should be adjusted and attempts to clarify why the unemployment rate can remain low despite a significant decrease in inflation.

He first pointed out that the risk balance faced by the Federal Reserve in "maintaining price stability" and "achieving full employment" has changed, and emphasized the importance of stabilizing the labor market at the current stage where inflation continues to fall to the 2% target:

"Four and a half years after the outbreak of the new crown epidemic, the most serious economic distortions caused by the epidemic are receding. Inflation has significantly decreased, and the labor market is no longer overheating. The current conditions are looser than before the epidemic. Supply constraints have normalized.

Our goal is to restore price stability while maintaining a strong labor market and avoid a sharp increase in the unemployment rate during the early tightening period when inflation expectations are not stable."

When it comes to inflation, Powell praised the progress in cooling inflation, saying "after pausing earlier this year, we are starting to move towards the 2% target again. I am increasingly confident that the inflation rate will sustainably return to the level of 2%."

He believes that this is mainly due to the contractionary monetary policy helping to restore the balance between total supply and total demand, alleviate inflationary pressures, and ensure that inflation expectations remain stable, making "inflation now closer to our target, with prices rising 2.5% over the past 12 months."

When assessing the job market, he asserts, "Nowadays, the labor market has cooled down significantly from the previous overheating state, and it seems unlikely that the labor market will be a source of upward pressure on inflation in the short term. We do not seek or welcome further cooling of the labor market conditions."

Specifically, the US non-farm unemployment rate has been rising for over a year, currently at 4.3%, although still relatively low by historical standards, it has increased by a full percentage point since the beginning of 2023, with the majority of the rise occurring in the past six months.

But Powell is trying to defend the current solidity of the US economic situation, saying:

"So far, the increase in the unemployment rate is not a result of increased layoffs, which is common during economic downturns. Instead, the rise in the unemployment rate mainly reflects a significant increase in the labor supply and a slowdown in the previous frenzied hiring pace.

Nevertheless, the cooling of the labor market situation is evident. Employment growth remains solid, but has slowed down this year. Job vacancies have decreased, and the ratio of job vacancies to the number of unemployed has returned to pre-pandemic levels. Nominal wage growth has slowed. Overall, the labor market situation is not as tight as it was before the outbreak of the pandemic in 2019, when the inflation rate was under 2%.

Overall, the economy continues to grow steadily (solid). However, inflation and labor market data show signs of change. The upward risks of inflation have diminished, while the downward risks of employment have increased. The Federal Reserve is concerned about the risks faced by its dual mandate.

Powell further stated that the Fed "will do everything possible to support a strong labor market while further achieving price stability", and explicitly pointed out that a rate cut is the future policy direction:

"By appropriately reducing policy constraints, we have every reason to believe that the economy will recover to a 2% inflation rate while maintaining a strong labor market. Our current policy rate level provides ample room to address any risks that may arise, including the risk of further deterioration in the labor market situation."

Powell: The disappearance of the collision between overheated and temporarily distorted demand and limited supply has eased inflation, and there is no need for the economy to weaken.

In the second part of the speech, Powell dedicated more space to discussing the fluctuations of inflation before and after the COVID-19 pandemic, and explored why inflation could significantly decrease while the unemployment rate remained low, seemingly painting a rare picture of the US economy achieving a "soft landing".

However, some analysts argue that during the COVID-19 pandemic, the Federal Reserve failed to raise interest rates in a timely manner to counter the surge in inflation. Powell's remarks highlight the fact that, at a time when price growth is slowing, Federal Reserve officials hope to avoid making policy mistakes again. Their success will determine whether the Federal Reserve can achieve the so-called "soft landing," which involves curbing runaway inflation without plunging the economy into a recession.

Powell stated that the rapid outbreak of the COVID-19 pandemic caused a global economic shutdown. After experiencing the most severe but short-lived recession in history, the US economy began to grow again from mid-2020, with Congress providing substantial additional fiscal support. This led to a strong recovery in spending in the first half of 2021, but with a change in pattern, namely a historic surge in consumer spending on goods and a suppression of spending on services.

At the same time, the pandemic severely disrupted the supply situation. At the beginning of the outbreak, 8 million people left the labor market in the United States, and as of early 2021, the labor force was still 4 million people lower than before the pandemic, not returning to pre-pandemic levels until mid-2023. In March and April 2021, inflation also manifested in shortage goods such as automobiles and rose significantly.

However, the Federal Reserve, most mainstream analysts, and central banks of developed economies generally believe that the sudden rise in inflation is temporary and as long as inflation expectations remain well anchored, there is no need to use monetary policy to deal with inflationary pressures that will soon pass. "At that time, people generally expected that the supply situation would improve fairly quickly, rapid recovery in demand would happen naturally, and demand would shift from goods to services, thereby reducing inflation."

However, starting from October 2021, inflation data contradicted the assumptions mentioned above, with inflation rising and expanding from goods to services. Strong measures are necessary to maintain stable inflation expectations, starting from March 2022, the Federal Reserve aggressively raised interest rates. By early 2022, the overall inflation rate exceeded 6% and the core inflation rate exceeded 5%. The Russia-Ukraine conflict and the resurgence of the pandemic brought new supply shocks.

Powell stated that high inflation rates at that time were a global phenomenon, reflecting people's shared experiences: rapid growth in demand for goods, supply chain tightness, labor market tightness, and significant increases in commodity prices. The US inflation rate reached a peak of 7.1% in June 2022, and the shortage of labor was also extremely severe at the same time. However, the number of employees increased by more than 6.5 million compared to mid-2021.

Therefore, at that time, the Federal Reserve made it a top priority to combat inflation, quickly raising interest rates by 425 basis points in 2022 and an additional 100 basis points in 2023. Since July 2023, the benchmark interest rate has remained at a high level not seen in over 20 years, reducing inflation by 4.5 percentage points from its peak two years ago, while the unemployment rate remains low, which is quite rare in history.

Powell believes that the distortion of supply and demand caused by the epidemic, as well as the severe impact on the energy and commodity markets, are important driving factors for high inflation, and the reversal of these factors is a key component of inflation reduction, although the fading of these factors takes much longer than expected:

Our contractionary monetary policy also helps to moderate total demand, coupled with improvements in total supply, reducing inflationary pressures and maintaining healthy economic growth.

As labor demand moderates, the high job openings-to-unemployment ratio has returned to normal, mainly through a decrease in job vacancy rates, without large-scale and disruptive layoffs, to prevent the labor market from being a source of inflationary pressures.

Therefore, he believes that most of the reasons for the rise in inflation during the COVID-19 pandemic can be attributed to the unusual collision between "overheated and temporarily distorted demand" and "constrained" supply. When this collision disappears and inflation expectations are anchored under the strong action of the central bank, inflation can be cooled without the need for economic slack.

Finally, Powell concludes that the Federal Reserve is committed to making appropriate adjustments to its principles through a comprehensive public review once every five years. When this process begins later this year, it will be open to criticism and new ideas while maintaining the advantages of its framework.

The limitations of our knowledge, as evident during the epidemic, require us to remain humble and skeptical, focusing on learning from the past and flexibly applying it to current challenges.