Fire in the (Jackson) Hole

20 August 2025

The upcoming Jackson Hole meeting will be the last one for Jay Powell as Fed Chair. The big picture question is whether Powell affirms market expectations for a quarter point cut at the September meeting. The Fed has dual objectives – inflation and full employment. The current outlook for both is finely balanced in both directions, in our humble opinion. Let us elaborate.  

This time last year the Fed faced a different set of uncertainties. The unemployment rate had moved up by 70 basis points from its cycle low. Historically that was a good indication of future accelerated rises in unemployment. At the same time, mid-term market-based inflation measures were falling, and real interest rates had increased. The proactive or pre-emptive September 2024 rate cut was probably warranted, especially in the context of the high starting point and given that rates had been held at a level firmly above neutral for over a year.

In contrast, the starting point today is 100 basis points lower and market-based measures of inflation are probably too high. That observation is consistent with broad financial conditions (tight credit spreads and strong equity prices) that are very loose. The unemployment rate has also been very steady over the past 12 months. Put another way, the uncertainties the Fed faces today are potentially more centric to its inflation mandate. We would also note the turn in pipeline inflation pressures which tend to lead headline consumer prices (chart 1).

Chart 1

Source: Bloomberg

When viewed objectively, the FOMC probably ought to keep rates on hold in the near term. However, as we noted recently, although the unemployment rate remains low, leading indicators of the labour market (job openings, temporary hires, and ISM employment) undercut the resilient labour market narrative.  Put another way, the data indicate fragility under the surface: where headline strength masked a rolling deterioration. Just like in 2008, we may be mistaking lagging indicators (like the unemployment rate) for structural health, when leading indicators (job cut announcements) are screaming stress (chart 2). Nonetheless, downward revisions ought not be a valid argument for a rate cut on their own.

Chart 2

Source: Bloomberg

For markets, the FOMC will likely need to see further deterioration in the labour market in August to cut the funds rate at the September meeting. Given a 25-basis point cut is priced (85% odds) any hawkish communication might disappoint investors. In that context, we would note the outperformance of profitless tech (+65% year to date) and speculative sectors that benefit from super-abundant liquidity. Market breadth has been extremely narrow and concentrated in the key AI-related narrative. Risk compensation is poor for the global risk proxy – the S&P500. The US market has only been more expensive in 5% of historical observations.

The final point to note is that rate cuts are almost never the bold, pre-emptive acts that policymakers like to frame them as. They are reactive by design or a signal that something beneath the surface has cracked. Stated differently, the Fed doesn’t ease when macro conditions are healthy; it cuts when stress is visible to insiders. Soft landings are the exception, not the rule. Before the first tech crash, the Fed commenced cutting in early 2001, but unemployment kept rising for another year as the economy deteriorated. For equities, when the Fed has been forced to cut rates, it has not been an “all clear moment” but rather the onset of an earnings recession. There are differences, however, the parallels to the first technology episode are disturbing in behavioural and valuation terms.

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