The global market is focused on one place this week: Jackson Hole, USA.

Author: Zhang Yaqi, Wall Street Insights

From August 21 to 23, global investors will focus on the mountain resort of Jackson Hole in Wyoming, USA. Here, Federal Reserve Chairman Jerome Powell's speech will not only provide key clues for the future path of U.S. monetary policy but may also become a pivotal moment in defining his career and defending the independence of the Federal Reserve.

The market is holding its breath. Investors generally expect the Federal Reserve to lower interest rates in the coming weeks, a sentiment that has driven the stock market, particularly interest rate-sensitive sectors, to historic highs. Any signals that contradict this expectation could trigger significant market turbulence. Powell's speech will be one of the most closely watched central bank events of the year, as he needs to soothe the market while providing solid economic rationale for the Fed's decisions.

Behind the speech lies immense political pressure. The Trump administration's criticism of Powell's failure to lower interest rates is growing increasingly intense, and they are even looking for potential replacements. This puts every public statement by Powell under the spotlight, and the Jackson Hole conference is the best platform for him to clarify his position and emphasize the independence of the central bank.

Powell is facing a tricky economic dilemma. On one hand, the tariff policy of the Trump administration is driving up inflation, complicating interest rate cut decisions; on the other hand, there are signs of cooling in the labor market, and the risk of slowing economic growth cannot be ignored. Amid conflicting economic signals and ongoing political interference, every step Powell takes is like walking on thin ice.

Unexpected Risks of Hawkishness

Wall Street is prepared for interest rate cuts. Data from the federal funds futures market shows that the market believes there is over a 92% chance that the Federal Reserve will cut rates by 25 basis points at its September meeting, and expects at least one more rate cut this year.

This dovish expectation has translated into actual actions in the market. Interest-sensitive sectors have become the big winners recently. Leading homebuilders such as PulteGroup, Lennar, and D.R. Horton saw their stock prices rise between 4.2% to 8.8% over the past week, far exceeding the S&P 500's increase of 1%. Andrew Slimmon from Morgan Stanley Investment Management stated:

"All of this is related to residential builders, cyclical stocks, and industrial and materials companies."

However, these price increases have also made the market exceptionally fragile. Slimmon added that the strong rebound of residential builders indicates that the market firmly believes the Federal Reserve will cut interest rates, so "any signals from Jackson Hole suggesting otherwise will make the market more susceptible to sell-off impacts." IBKR's market strategist Steven Sosnick also warned that:

"What should we do if people are eagerly anticipating a dovish Powell, but he instead comes out swinging with a hawkish stance? The more complacent we feel going into this meeting, the greater the risk of market volatility reactions."

Difficult Choices Under Political Pressure

Powell's cautious attitude stands in stark contrast to the urgency of the Trump administration. President Trump not only publicly called Powell a "stubborn idiot," accusing him of being "too late," but also hinted at the possibility of firing him before the end of his term. The White House is screening potential replacements, focusing on candidates willing to cut interest rates quickly.

This political interference has made the Federal Reserve's decision-making exceptionally difficult. Powell has maintained the federal funds rate in the range of 4.25%-4.50% primarily due to concerns that Trump's tariff policies may exacerbate inflation. Historically, similar political interference has led to disastrous consequences. In the 1970s, pressure from the Nixon administration caused then-Federal Reserve Chairman Arthur Burns to keep interest rates low during rising inflation, ultimately triggering double-digit inflation.

Powell admitted that tariffs "could lead to rising inflation, slowing economic growth, and increased unemployment," which complicates any decision by the Federal Reserve. If interest rates are cut too soon, it could fuel inflation; if rates are kept unchanged, it could exacerbate the weakness in the labor market.

Mixed Economic Data

Current complex economic data is fueling this debate. Although the US economy has largely avoided recession, achieving some form of "soft landing," the road ahead is fraught with uncertainty.

On one hand, inflationary pressures remain stubborn. The core Consumer Price Index (CPI) rose by 0.3% month-on-month in July, marking the largest increase since January, with an annual rate reaching 3.1%. The Producer Price Index (PPI), which measures wholesale inflation, soared by 0.9% last month, the largest monthly increase in over three years. These data indicate that tariffs may have begun to raise corporate costs, which will eventually be passed on to consumers.

On the other hand, the labor market is cooling down. In July, the U.S. added only 73,000 jobs, while employment data for May and June were significantly revised down by more than 250,000. Wage growth has slowed from an annual rate of 6% in 2022 to about 3.9%. This data has also led to divisions within the FOMC, with two members voting to support a rate cut at the July meeting.

The Legacy War for Defending Independence

In the face of a complex situation, Powell is expected not to reveal the September interest rate decision in advance at Jackson Hole. Instead, his speech will focus on the Federal Reserve's assessment of its monetary policy framework, which occurs every five years. This is seen as a key strategy for him to defend the long-term independence of the Federal Reserve.

By adjusting the policy framework, Powell can establish some guiding principles that can transcend his term, such as how to respond to supply shocks and how to rebalance the twin goals of full employment and price stability. William English, a professor at Yale School of Management and former senior official at the Federal Reserve, predicts that the Fed may revert to using "deviations" instead of "shortfalls" to describe employment conditions. This slight semantic shift implies that both an overheated and a cooled labor market are issues that need to be addressed, thereby giving the Fed equal justification to raise or lower interest rates under different circumstances.

RSM US Chief Economist Joe Brusuelas stated:

"My feeling is that he views his legacy as preserving the independence of the Federal Reserve."

The speech at Jackson Hole will not put an end to this battle, but it will demonstrate how Powell balances the three roles of managing the economy during a transition, responding to political hostility, and refining the decision-making framework. This is not just about a rate decision; it concerns the ability of the U.S. central bank to maintain its independence in the midst of the storm.