Hi friends,

This morning, Jerome Powell spoke at the Central Bank Policy Forum alongside ECB’s Christine Lagarde and Banco Central do Brasil’s Roberto Campos Neto.

Powell’s discussion is particularly of our interest because 1) the recent inflation data have been benign, and 2) the market is pricing in 2 cuts before the year-end, despite the fact that the June FOMC Dot Plot median suggests 1 cut.

Here is the full video, but we do a quick breakdown of Powell’s latest stance on the labour market, inflation, rate cuts, government deficit, and trade tariffs below.

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.

1. Labour market is cooling off appropriately

Powell emphasised that the labor market remains strong. Powell highlighted that the labor market is cooling off appropriately, but not too rapidly. This is important as “maximum employment” is part of the Fed’s dual mandate

While the unemployment rate has risen to 4% from a low of 3.4%, this level is still historically low. We had to go back to 1969 to find the 3.4% unemployment rate.

The vacancies to unemployment ratio is coming back to where it was pre pandemic. The dynamics of the labour market are riding along the famous “Beveridge Curve”, which captures an inverse relationship between unemployment and vacancies.

The conclusion is that the labour market does not “look like it's heating up or presenting a big problem for inflation”.

2. Inflation resumes its disinflationary trend

Down from a peak of 7.1% and 5.4% in the headline and core PCE to the latest 2.6% (released last Friday), Powell is encouraged by the progress towards the Fed’s 2% target.

However, the persistence of services inflation (“such a mixed bag”), which is tied to wages, means Powell is still cautious. Even rent increases are much longer than the Fed expected to work their way off.

The Fed hopes that the cooling down of the labour market could move wage increases back down towards a sustainable level for inflation.

This means a need for more consistent data to ensure inflation is genuinely moving towards this target sustainably. It is important that the Fed gains confidence that the inflationary resurgence in Q1 was just a temporary spike.

3. No date on the first rate cut yet

When asked about a September cut, Powell kept a tight lip.

What’s clear is that the Fed is not in a rush to cut rates. While the risks of inflationary resurgence versus harming economic growth is balanced, the Fed wants to see more data on the sustained progress towards the 2% target.

To me, this means at least 3 months of consecutively benign PCE and CPI prints.

Fed Funds Futures slightly bull flattened

The Fed Funds futures were largely unchanged after the speech, with the 2025 yields down 3-5bp.

This means the market is still expecting rate cuts in September and December. The curve may change if we get some very ugly data in the coming months, or the Fed explicitly refutes the September expectation.

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— Yimin