Powell's speech signals a policy shift: labor market risks emerge, and the Federal Reserve is contemplating policy adjustments.

Federal Reserve Chair Powell delivered a significant speech at the Jackson Hole Economic Symposium, signaling a clear policy tilt. Against the backdrop of a continuously cooling labor market and slowing economic growth, this speech marks the Fed’s shift from defensive inflation control to a focus on employment, laying the groundwork for the next steps in monetary policy adjustments. Every statement in Powell’s speech has been carefully considered, reflecting the complex balancing act the Fed faces—how to find new policy levers between controlling inflation and stabilizing employment.

The Logic Behind Rate Cuts in the “Unusual Balance” of the Labor Market

The current labor market exhibits an unprecedented contradictory state. Although the unemployment rate remains at a historically low 4.2%, job growth has noticeably slowed—over the past three months, average monthly employment gains are only 35,000, far below last year’s average of 168,000. This phenomenon should have triggered alarms, but it is masked beneath surface stability.

Powell describes this situation as an “unusual balance,” fundamentally caused by a synchronized contraction in labor supply. Tightening immigration policies have led to a sharp decline in labor force growth, and labor force participation has also decreased. In short, the reason the unemployment rate remains stable is not because the job market is strong, but because supply-side growth is equally weak. This false equilibrium conceals significant risks—any negative shock to the economy could cause the unemployment rate to rise rapidly.

Powell points out that this abnormal situation suggests increasing downside risks to employment. If risks materialize, they could quickly manifest as a surge in layoffs and a rapid rise in unemployment. This assessment directly supports the need for policy adjustments. The stability of the unemployment rate and other labor market indicators allows the Fed to cautiously consider policy shifts, opening the door for potential rate cuts.

Tariff Impact and Inflation Expectations: A New Balance in Policy Framework

Changes in inflation dynamics are also noteworthy. While the overall PCE inflation rose 2.6% annually and core PCE reached 2.9%, the structural changes behind these figures warrant deeper reflection. Tariff policies have begun to push up prices of certain goods, with goods-related PCE increasing by 1.1% over the past 12 months, contrasting with a mild decline in the previous year.

Powell’s remarks on tariffs contain important policy signals. He used the phrase “reasonable baseline assumption,” suggesting that tariffs’ impact on prices is mostly a “one-time” jump. In other words, the Fed tends to view this wave of price pressures as temporary and unlikely to evolve into persistent inflation dynamics. Of course, “one-time” does not mean “instantaneous”; tariff adjustments still take time to fully transmit through supply chains and distribution networks.

However, the Fed remains confident in anchoring inflation expectations. Long-term inflation expectations remain aligned with the 2% target, and market and survey data show expectations are stable. This confidence allows the Fed to adopt a relatively proactive policy stance without excessive concern that price increases will trigger persistent inflation. Powell repeatedly emphasizes that regardless of what happens, the Fed will never allow a one-time price level increase to evolve into a sustained inflation problem.

Market Interpretation and Practical Implications

Media outlets like Wallstreetcn quickly interpreted Powell’s subtle signals. A well-known journalist, dubbed the “New Fed Communications Agency,” pointed out that Powell’s mention of stable labor market indicators like the unemployment rate suggests the Fed can cautiously consider policy adjustments, opening the door for a tentative rate cut at the earliest next meeting. This consensus reflects the market’s understanding: the Fed is gradually shifting from a neutral stance toward easing.

More subtly, the journalist further noted that Powell’s first hint of increased confidence in the baseline assumption—that tariff-induced price increases will be relatively short-lived—is significant. This confidence stems from an understanding of labor market slack. If the tightness in the labor market is insufficient to support stronger wage negotiations by consumers, wage pressures will not push up prices, making the “one-time price increase” hypothesis more plausible.

Evolution and Adjustment of the Fed’s Monetary Policy Framework

The second part of Powell’s speech involved a systematic revision of the Fed’s monetary policy framework, reflecting the profound changes in the economic environment over the past five years. Compared to five years ago, when concerns centered on interest rates hitting the effective lower bound (ELB), with low growth, low inflation, and a flat Phillips curve, the current situation is markedly different—policy rates are well above historic lows, and inflation has reached a 40-year high.

The key changes in this framework revision include three aspects. First, the Fed removed the emphasis on the ELB, instead stating that “monetary policy strategies aim to promote maximum employment and price stability under broad economic conditions.” Second, the Fed reverted to a flexible inflation targeting framework, removing the “compensatory” strategy introduced in 2020. The reason for this removal is that practical experience has shown that deliberately and moderately overshooting inflation as a strategy is no longer appropriate—actual inflation has not been deliberate nor moderate.

The third change concerns the wording around employment goals. The previous phrase “mitigate shortages of full employment” was replaced with a more precise statement—acknowledging that employment can sometimes exceed the estimated full employment level without necessarily risking price stability. This change reflects the Fed’s recognition of the uncertainty around the natural rate of unemployment and emphasizes the importance of anchoring inflation expectations.

The Fed also underscores the critical role of anchoring inflation expectations. Anchored expectations have contributed to successfully containing inflation over the past few years without raising unemployment. Conversely, unanchored inflation expectations could trigger a vicious cycle—consumers expect higher prices and demand higher wages, firms raise prices to cover costs, and inflation becomes self-reinforcing.

Policy Implications and Outlook

Overall, Powell’s speech conveys a policy message that is clear and profound. In the short term, inflation risks are tilted upward, while employment risks are tilted downward, creating a challenging scenario. In response to this imbalance, the Fed signals a commitment to balancing its dual mandate. The policy rate has moved closer to the neutral level, and the stability of unemployment and other labor indicators allows the Fed to cautiously consider further policy adjustments.

It is noteworthy that Powell emphasizes that monetary policy is not on a preset path. FOMC members will make decisions based on data and their assessment of the economic outlook and risks. This means policy adjustments will remain flexible and data-dependent, rather than following a predetermined schedule.

Under this framework, Powell’s speech has garnered significant market attention. The seemingly technical adjustments to the policy framework actually reflect the Fed’s strategic shift in responding to the new era of economic challenges. Moving from defensive inflation control to balancing employment and prices, from emphasizing ELB risks to adapting to a more complex policy environment, the Fed is building a more flexible and realistic toolkit. For financial markets and the real economy, this speech marks the beginning of a new era.