What made Powell blink?

In his much-awaited speech at the annual Jackson Hole central bankers’ symposium, his last as Chair of the Federal Reserve (Fed), Jerome Powell delivered a dovish surprise by opening the door wide to a rate cut at the FOMC’s upcoming meeting, his tone a long way away from his hawkish press conference following the July 30 FOMC meeting, and its hawkish minutes, published just days before the speech. Markets cheered, with both stocks and bonds rallying. Were they right to? Much depends on what caused the shift. Was it relief from inflation developments? Heightened fears of recession? Giving in to political pressure? Chair Powell himself assigned it to a “shifting balance of risks”. But what does this actually mean? We see four layers of explanations: the data; the reaction function; the casting; and the politics.

The data

The August 1 employment report drew the spotlight by revealing that job creations had been much lower than expected not just in July but also in the prior two months, leaving employment barely higher at end July than in April. Nonetheless, the unemployment rate edged up only slightly to 4.2%, still an historically low level. But data on the inflation side of the Fed’s dual mandate also moved away from the Fed’s target, with both retail and wholesale price inflation accelerating in July to exceed 3%. Moreover, industry surveys confirm that most firm intend to pass through to consumers the price increases they face owing to tariffs, and several measures of inflation expectations also rose in August.

This tension between the two sides of the Fed’s mandate is unfortunate to be sure, but was in fact anticipated by the FOMC at its July meeting. Plausibly, what wasn’t was the scale of the slowdown in the pace of job creations.

The reaction function

Speaking on the heels of the last FOMC meeting, Chair Powell emphasized that the relevant metric of achievement of the Fed ‘s “maximum employment” mandate was the unemployment rate. He waved off concerns about slowing jobs growth on the grounds that both the demand and supply sides of the labour market appeared to moderate at the same pace, leaving the market broadly in balance.

While this dynamic is still very much at play, Chair Powell in Jackson Hole acknowledged this was "a curious kind of balance", seemingly ditching his earlier analysis in favour of the less benign one promoted for some time by Governor Waller (who voted for a cut at the July meeting). This argues instead that downside risks are rising and the observed balance could quickly give way to sharply higher layoffs and unemployment.

Gone is the previous emphasis on the greater distance of inflation from its target and hence the need to address this risk first. Instead, Chair Powell noted that while a risk existed that the impact on prices of tariffs passthrough would not be short-lived, this did "not seem likely", again rallying to the long-held Waller view. But why now, when the minutes of the July FOMC meeting make clear that this was a minority view then?

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