[Why&Next] Powell's Time... The World's Eyes on 'Jackson Hole'

'Prolonged Tightening' View Prevails... Fed Rate Outlook Diverges
Jackson Hole Shock Repeated? Market on Edge
Bank of Korea Alert... US Prolonged Tightening & China Slowdown Variables

'Is this the end of tightening, or a prolonged period of high interest rates?'

As Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), prepares to deliver his speech at the Jackson Hole meeting on the 25th (local time), the eyes of global financial markets are focused on him. Depending on whether the economic powerhouse, the United States, signals the end of tightening or predicts a 'new normal' of high interest rates, Powell's message will provide clues about the direction of U.S. monetary policy. Last year, Powell shocked global financial markets with a bombshell statement that he would continue raising interest rates despite the pain to households and businesses to curb inflation, causing the so-called 'Powell shock.' This year, with expectations that he might deliver a strongly hawkish (favoring monetary tightening) message again, market tension is rising.

[Image source=Yonhap News]

Will Powell reveal hawkish tones... Focus on whether he mentions the 'neutral rate'

Powell will deliver the keynote speech titled 'Structural Changes in the Global Economy' at 10:05 a.m. (Eastern Time, 11:05 p.m. Korean time) on the 25th at the annual economic symposium held in Jackson Hole, Wyoming. This is the highlight of the three-day Jackson Hole meeting, which runs from the 24th and is attended by central bank governors from around the world.

The market widely expects Powell to indicate that the tightening stance will continue for some time. Although the consumer price inflation rate has slowed to the 3% range for two consecutive months, down from the peak of 9.1% in June last year, the U.S. economy continues to show strength centered on consumption and employment, raising concerns that inflation could be reignited. While the prevailing view is that the Fed's tightening is nearing its end, the unexpectedly strong U.S. economy could keep interest rates at higher levels for longer. The argument is that there will be no pivot (a change in monetary policy direction), i.e., no interest rate cuts, for the time being.

In particular, whether Powell mentions the possibility of an upward revision of the neutral interest rate is key. The neutral rate is a theoretical interest rate level at which the economy can achieve its potential growth rate without overheating or recessionary pressures. Even though the Fed has raised the benchmark interest rate to 5.25-5.5%, the strong state of the U.S. economy has led some to analyze that the neutral rate itself has risen. This supports the claim that high interest rates have become the 'new normal.' Vanguard Group in the U.S. estimates that the real neutral rate has risen from the previous 0.5% to the current 1.5%.

If Powell mentions at the Jackson Hole meeting that the neutral rate has risen, it would mean the Fed has concluded that rate hikes are not sufficiently tight to pressure the economy. This could lead to further rate hikes or a prolonged period of high interest rates by the monetary authorities. David Mericle, a strategist at Goldman Sachs, predicted, "If the Fed discusses the rise in the real neutral rate (at Jackson Hole), the urgency for rate cuts will diminish accordingly."

However, if Powell states that the neutral rate has not changed significantly, the market is expected to interpret the Jackson Hole speech as dovish (favoring monetary easing). Previously, in December last year, Powell said, "We do not clearly and precisely understand what the neutral rate and the real interest rate are," indicating that monetary policy would not be based on the neutral rate.

Diverging Fed rate forecasts... South Korea faces prolonged U.S. tightening and China's recession as variables

As the Jackson Hole meeting opens, Fed officials have expressed differing views on whether additional rate hikes are necessary. Susan Collins, President of the Boston Federal Reserve Bank, said in interviews with Yahoo Finance and the Financial Times (FT) that "further rate hikes may be necessary." Collins, who does not have voting rights in this year's Federal Open Market Committee (FOMC), explained, "More evidence may be needed. We may be very close to a position where rates need to be maintained for a considerable period," but added, "I will not signal exactly where the peak is at this time." James Bullard, former President of the St. Louis Fed and considered a representative hawk, also forecasted, "Such economic acceleration could put upward pressure on inflation and suppress the disinflation we are seeing," adding, "This could delay the Fed's plan to change (end tightening) monetary policy." He had delivered similar messages in an interview with the WSJ released the day before.

On the other hand, Patrick Harker, President of the Philadelphia Fed, stated that no further rate hikes are necessary. In an interview with CNBC at Jackson Hole, he emphasized, "We have probably taken sufficient action," and that "(rates) are at a restrictive level and should be maintained at this level for some time." Considered a representative dove within the Fed, he mentioned that rate cuts could be possible next year depending on data. He said if inflation indicators fall faster than expected, "we could cut rates sooner," but added, "However, I think we need to maintain this for the time being."

The message Powell delivers and the September FOMC decision are expected to determine the direction of monetary policy for major central banks, including South Korea. Lee Ju-yeol, Governor of the Bank of Korea, said right after the Monetary Policy Committee decided to keep the base rate at 3.5% for the fifth consecutive time, "We are watching to see if much more hawkish remarks will come out at the Jackson Hole meeting." Previously, the Bank of Korea independently kept rates unchanged for five consecutive times, separate from Fed monetary policy. However, if the Fed confirms a prolonged tightening stance at Jackson Hole, it will be difficult to avoid pressure to raise rates due to increased volatility in the foreign exchange market. Governor Lee explained that the Monetary Policy Committee "is focusing more on the possibility of rate hikes rather than cuts until the end of the year."

The worst-case scenario the Bank of Korea fears is that the Fed prolongs high interest rates while China's real estate-driven economic crisis materializes. Especially if the Chinese economic crisis becomes visible, the Bank of Korea would need to lower the base rate to focus on growth, but if the U.S. maintains high rates, concerns about capital outflows and foreign exchange volatility would make it difficult to cut rates. The Bank of Korea has maintained its economic growth forecast for South Korea at 1.4% this year, but if China's growth rate falls to 4.5%, South Korea's growth could drop to as low as 1.2%. Governor Lee said, "If the U.S. maintains a prolonged tight monetary policy, it will be a dilemma for us," adding, "Even if we want to lower rates considering the real economy when our financial market stabilizes and household debt adjusts, if the U.S. maintains high rates, a conflicting relationship could arise."