Author: Macro Analyst Song Xuetao/Tianfeng; Contact: Tianzhong; Source: Xuetao Macro Notes

Powell's most important correctness is "political correctness".

The FOMC meeting in September lowered interest rates by 50bp more than expected, revised the year-end unemployment rate forecast to 4.4% (4.0% in June), lowered the year-end core PCE to 2.6% (2.8% in June), and further raised the long-term Intrerest Rate to 2.9%.

Following the Jackson Hole meeting, the Fed declared victory over inflation by implementing a substantial 50bp interest rate cut, thus initiating a new cycle of rate cuts.

**Throughout the entire press conference, Powell did not provide strong arguments for a 50bp rate cut, but repeatedly emphasized "doing the right thing". However, judging from recent economic indicators, a 50bp rate cut may not necessarily be the right move."

Since August, core inflation has rebounded, wage growth has rebounded, employment conditions have improved, retail sales have exceeded expectations, the entire real estate chain has warmed up, the service industry PMI has maintained a substantial expansion level, and industrial production has repaired beyond expectations, all of which have denied the urgency of a significant interest rate cut.

As we explained in 'Understanding the Logic of Fed Actions', Powell's dovish shift is not economic logic, but political logic. From an economic perspective, it is reasonable to cut interest rates by 25BP or not to cut at all; from a political perspective, there is nothing wrong with cutting rates by 50BP or even 75BP. Recently, Democratic Senator Elizabeth Warren called on the Fed to cut rates by 75BP before the election.

This has led to a situation where, during the silent period of Fed officials and consistent improvement in economic data, the 50BP rate cut expectation can continue to heat up by relying on the former New York Fed chairman and media guidance. Powell chose to converge with market expectations, conforming to financial market pricing, rather than the proactive 'expectation management' done before.

This is not a compensatory rate cut. If the Fed really thinks that the July non-farm data points to the need for a rate cut, it should openly guide more clear rate cut expectations (25bp+25bp) after the data is announced, rather than let the market speculate on the possibility of 25bp and 50bp during the silent period.

In September, the forecast of 4.4% for the unemployment rate in 2024 and 2025 is also difficult to be self-consistent: historically, the unemployment rate is unlikely to stay at a stable level, but such a large labor supply shock has never occurred in history, and the unemployment rate is full of too much uncertainty. (See "Recession Concerns and Loose Non-Landing")

The entire U.S. labor market has been caught up in the uncertain influx rate of illegal immigrants (including the time it takes for illegal immigrants to transition into the labor force and the level of participation), and the current number of illegal immigrants recorded by the U.S. Border Patrol has significantly decreased.

Such decisive monetary policy adjustments and relatively proactive interest rate paths do not take into account the marginal weakening of labor supply, combined with the demand recovery brought by interest rate cuts, there is a possibility of a downturn in the US unemployment rate.

**Looking back now, Powell's idea of 'correctness' is not based on economic factors, but more on political 'preference'.

When Biden's approval rating lagged behind Trump, Powell tried to maintain a vague neutral position. However, when Harris took over from Biden and her approval rating surpassed Trump's, his attitude quickly turned dovish. With the Jackson Hole speech of 'doing everything possible,' he initiated a interest rate cut cycle. (See 'Powell's Dove Transformation' for details)

**Interestingly, Powell mentioned in the press conference that he has experienced four presidential elections as Fed chairman, and "each time was a collective decision based on maximizing the interests of the American people".

However, in 2016, the Fed made every effort to avoid interfering in the election and only raised interest rates after the election. Moreover, for the current US economy, there is more than enough time to take action after the election.

Before this, Trump threatened to replace Powell and urged him not to cut interest rates before the election, which may have ironically resulted in this 50BP rate cut.

Overall, this is a significant interest rate cut driven by non-economic factors, which may increase the risk of secondary inflation. The US economy, stimulated by the interest rate cut at a relatively high level (Figure 7: Economic Momentum Index at the highest level of the soft landing cycle), will lead to a demand rebound and inflation rebound, and the Fed may consider raising interest rates again next year. (See 'Only One Interest Rate Cut Away from Secondary Inflation')

The significant Fluctuation has further distanced Powell from his idol (Paul Volcker), the predecessor of 70s Fed Chairman Arthur Burns. (See "Powell is destined to be the Burns of the 21st century")

Risk Warning

The U.S. unemployment rate data has a significant deviation, U.S. corporate profits are slowing down beyond expectations, unexpected events in the U.S. election are recurring, and the uncertainty of U.S. wage growth is increasing