Fed Turns the Page: What Investors Need to Know

In this article we review:

• Federal Reserve Chair Jay Powell’s Review and Outlook speech made at the Jackson Hole Economic Symposium
• Why we believe the Fed has now shifted monetary policy more toward maximizing employment rather than fighting inflation
• Why recent employment revisions made by the U.S. Bureau of Labor Statistics are consistent with the Fed’s changing emphasis
• Why we believe the Fed will begin reducing in September and likely conclude the year with a fed funds target range of 4.50–4.75%, with more rate cuts to follow in CY 2025

In his Review and Outlook speech on August 23 at the Jackson Hole Economic Symposium sponsored by the Federal Reserve Bank of Kansas City, it took Federal Reserve Chair Jay Powell less than 17 minutes to confirm that the Fed had shifted its primary focus away from battling inflation and toward the other half of its dual mandate, that of maximizing employment. In doing so, Chair Powell’s commentary further reiterated market expectations of fed funds rate reductions beginning at the upcoming September meeting.

Against this backdrop, we view the following points as important to investors:

• Turning the page. At the outset of his speech, Chair Powell assured listeners of his view that substantial progress had been achieved on inflation, specifically stating: “Inflation is now much closer to our objective ... My confidence has grown that inflation is on a sustainable path back to 2 percent.” In addition, Chair Powell also offered up a changing of the guard summary in saying, “The upside risks to inflation have diminished. And the downside risks to employment have increased.”
   
• Employment focus has taken center stage. Chair Powell made a point to reference that although the current unemployment rate stood below historical averages at 4.3%, it is now a full percentage point higher than its low of last year. Further comments on the present employment environment included, “… the cooling in labor market conditions is unmistakable. ... We do not seek or welcome further cooling in labor market conditions,” and, perhaps most directly, “The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions.” In our view, all this verbiage is representative of a series of rate cuts to be implemented by the Fed beginning at their upcoming meeting concluding on September 18.
   
• Revised jobs data supports upcoming Fed easing. On August 21, two days prior to Chair Powell’s speech, the U.S. Bureau of Labor Statistics (BLS) downwardly revised year-over-year nonfarm payroll gains in the U.S. economy for the 12 months ending March 2024 by 818,000 jobs. This amounted to close to 30% less than the previously stated job gains for this period (from 2.9 million to 2.1 million) and about -0.5% of the nation’s total labor base. While the BLS makes such revisions annually, this was the largest adjustment in 15 years, further supporting the growing premise of the overall jobs market not being as strong as previously believed. We view this revised economic data as consistent with expectations of Fed rate cuts beginning next month.
   
• Real rate of interest also implies upcoming rate cuts. The current real rate of interest, defined by the upper bound fed funds rate less the core rate of inflation, now stands at 2.9% (upper bound fed funds rate 5.5% minus personal consumption expenditures core inflation 2.6%), its highest level since 2007. The higher this rate, the more effective it is in combatting inflation, but the more restrictive it is in enabling economic growth. Therefore, we believe the Fed will soon seek to lower this differential via fed funds rate reductions to help fend off potential economic contraction.    
   
• We continue to expect a soft landing for the U.S. economy as the Fed acts in the months ahead. We do not believe the U.S. economy is likely to lapse into recession in the foreseeable future, and we maintain our forecast of cumulative gross domestic product growth of 2% for CY 2024. This forecast is dependent upon the Fed acting expeditiously beginning in September to help prevent real weakness in the labor markets.   

We reiterate our year-end 2024 fed funds rate target range forecast of 4.50–4.75%, representing three quarter-point rate cuts at the upcoming September, November, and December meetings. We also see potentially four more rate cuts in CY 2025, thereby concluding next year with a fed funds target range of 3.50–3.75%. Our year-end target for the 10-year U.S. Treasury Yield is approximately 3.75% and we see the current rate environment as favorable for stocks as well, as reflected in our S&P 500® price targets of 5,800 for YE 2024 and 6,300 for YE 2025.        

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