Commentary on the China International Capital Corporation (CICC) Jackson Hole Meeting: The Late-arriving Hawk and the Repair of Credibility

CICC published a research report stating that Federal Reserve Chairman Waller's speech at Jackson Hole reflected a hawkish stance: he acknowledged that inflation remains elevated, clarified that interest rates are still the primary policy tool, and indicated a willingness to act as necessary. He also referenced economic resilience, stable employment, and loose financial conditions to explain that current policy risks lean more towards inflation. Furthermore, he attributed the responsibility for 65 months of elevated inflation to the central bank itself, correcting the ambiguous statement made in July about allowing the market to replace the Federal Reserve in raising rates. The bank believes this speech helps to rebuild the Federal Reserve's credibility; after the speech, the market began adjusting to the marginal repair of policy credibility. In the long term, Waller insists that AI may reshape the economy and policy framework and continues to promote reforms such as reducing forward guidance. For the market, this recent statement has raised the probability of a Federal Reserve rate hike this year, but even so, it may not necessarily be purely bearish. Currently, the market is not lacking in liquidity; rather, it needs discipline and predictability in policy. As long as inflation can be timely contained, it would be beneficial for the market in the medium term. CICC's main points are as follows: Waller's Hawkish Tone Restores Federal Reserve Credibility Prior to this speech, a significant concern in the market stemmed from Wallers ambiguous comments at the July FOMC press conference, especially his statement about allowing the market to replace the Federal Reserve in raising rates, which raised doubts about the Federal Reserve's determination to combat inflation. This concern contributed to a rise in long-term U.S. Treasury yields. Therefore, the market generally hoped that Waller would provide some correction in todays speech. The bank's previous forward-looking commentary indicated that Waller's most critical task was to send clear signals to the market to restore the Federal Reserve's credibility. From the content of todays speech, Wallers response can be seen as targeting market concerns and largely confirms the bank's earlier assessment. Notably, he was clear and straightforward on inflation and monetary policy. Specifically, Waller emphasized the following points: First, inflation remains elevated, and the risks are not yet resolved. Waller stated that inflation has improved only marginally over the past two years, and this summer's better-than-expected PCE and CPI data do not sufficiently prove that inflation has undergone substantial improvement. He mentioned that over the past 12 months, 54% of the goods and services in the PCE basket saw price increases of over 3%this percentage has significantly decreased from about 77% during the pandemic peak but is still far above the 32% level of the previous two decades, indicating an unstable underlying inflation trend. At the same time, Waller clearly articulated that the 2% PCE inflation target is a firm, fixed target for maintaining price stability, which is the responsibility of the Federal Reserve. Second, interest rates are the core policy tool for addressing inflation. Waller stated unequivocally that short-term interest rates are the main tool for achieving the dual mandate, and that unconventional policy tools should only be used in response to genuine crises, being cautious in other circumstances and opting not to use them if possible. This suggests that adjusting the federal funds rate remains the preferred option for tackling short-term inflation, and balance sheet reduction cannot quench immediate thirst. In the medium term, Waller still intends to control the money supply through strict constraints on the balance sheet to curb inflationthis is a fundamental principle he adheres to within the monetarist school. However, this option is currently difficult to implement in a timely manner, and curbing inflation continues to rely on interest rate policy. Third, he does not rule out the possibility of further tightening if needed. Waller mentioned that at the July FOMC meeting, the consensus among Federal Reserve officials was that the labor market remains stable, but inflation is still too high. Therefore, he and the vast majority of his colleagues believe it is wiser to wait for new information between meetings to decide whether to adjust interest rates. He then explicitly stated that the committee is ready to act as circumstances might require. The Federal Reserve must be confident that underlying inflation is clearly moving towards the target at a sufficiently rapid pace; otherwise, we have work to do. At the end of his speech, Waller emphasized that the responsibility for the persistently elevated inflation over the past 65 months should fall on the central bank, as that is the obligation it must assume. The bank considers this statement to carry significant weight. Waller did not attribute the inflation exceeding the target since the pandemic to external factors such as supply chain disruptions, fiscal stimulus, tariff increases, or shocks to oil prices; rather, he clearly stated, the responsibility lies with the central bank and should indeed lie with the central bank. This effectively cuts off any "passing the buck" retreat, leaving no room for the Federal Reserve to offer excuses. From the perspective of building credibility, this statement corrected his prior comments about allowing the market to replace the Federal Reserve in raising rates, helping to restore market confidence in him. From the performance of asset prices, the market interpreted the speech as hawkish: the dollar strengthened, and gold prices fell, with the dollar index recovering all losses incurred since the Besant intervention in the bond market. The two-year Treasury yield rose sharply by 11 basis points, while the 30-year yield remained relatively stable, leading to a pronounced flattening of the yield curve. U.S. stocks fell, but the overall decline was limited. This response is largely consistent with the bank's judgment in its forward-looking commentary: if Waller demonstrates sufficient policy flexibility and reaffirms the markets confidence in the Federal Reserve's fight against inflation, the market will trade on the marginal repair of the Federal Reserve's policy credibility. U.S. stocks may experience a short-term pullback but could benefit in the medium term. Clearer communication helps reduce the policy risk premium, thereby lowering the likelihood of a significant rise in long-term Treasury yields. The Economy is Resilient, and Rate Hikes May Not Be Purely Bearish Waller's hawkish attitude is grounded in his relatively optimistic assessment of the U.S. economy, which he believes demonstrates considerable resilience, whether on Main Street or Wall Street. In terms of economic growth, Waller stated that corporate capital expenditures are rapidly increasing, with investments in equipment and intangible assets growing by about 9% over the past four quarters, the highest increase since 2021, with over half of this capital expenditure growth potentially stemming from AI developments. Meanwhile, despite various shocks, real personal consumption expenditures remain healthy, corporate profits are robust, and the market maintains high expectations for corporate earnings growth. In financial markets, the current credit spreads for corporate bonds and leveraged loans are close to historical lows, with strong issuance in both markets this year. Stock market volatility is relatively low. Bank commercial loans continue to grow, and there are almost no signs of tightening in the credit market. Certain sectors such as housing and agriculture are indeed under pressure, but overall, it is difficult to characterize the current financial situation as restrictive. In the labor market, Waller considers the 4.1% unemployment rate to be historically low, noting that when labor supply hardly increases, monthly job additions are naturally low. While there are concerns about employment among recent graduates, in general, those who want jobs mostly can retain or find work, indicating that the labor market is essentially characterized by full employment. Regarding inflation, the Federal Reserve's preferred inflation indicatorthe year-on-year increase in the PCE price index is 3.7%, and the six-month annualized rate is 4.1%, with core PCE also remaining elevated. Though these indicators are not perfect, they all run above the 2% target. Wage growth is moderate, but long-term experience shows that wage growth is not a reliable predictor of future inflation. The bank believes that while Waller did not explicitly support a rate hike at the September meeting, he has implicitly indicated a willingness to take further action if inflation remains stubborn. This suggests that the probability of a Federal Reserve rate hike increases. Following the speech, the interest rate futures market priced the probability of a rate hike at the September FOMC meeting at around 55%, up from 35% before the speech; the probability of at least one rate increase by year-end is nearly fully priced in. For the market, even if a rate hike occurs, it does not equate to purely bearish outcomes. If the increase in rates results from strong economic demand, the stock market may not necessarily continue to decline. Historical experience indicates that the market is not truly worried about rate hikes per se, but rather about the Federal Reserve raising rates too late. The year 2022 serves as a typical example: at that time, monetary policy lagged behind the curve, forcing the Federal Reserve to raise rates significantly and rapidly to curb inflation, ultimately causing the market to decline continuously. On the other hand, if rate hikes help mitigate inflation risks, coupled with strong fundamentals and corporate profits, this could be beneficial for the market in the medium term. Focusing on AI Transformation and Opposing Forward Guidance In his speech, Waller also dedicated significant time to discussing the long-term economic and policy framework, viewing artificial intelligence (AI) as a critical technological transformation that he believes will reshape future economic potential and development models. He holds an optimistic view of AI's ability as a general technology and believes that, with AI technology permeating, the U.S. economy could potentially emerge from the low productivity, low investment, low potential growth dilemma and enter a new phase. However, Waller did not express blind optimism and instead posed several important questions: First, can AI elevate overall social productivity? If so, when might that happen? If the productivity improvements from AI have widespread effects, it could expand total economic supply, thereby reducing long-term inflationary pressures and altering the equilibrium level of future interest rates. Second, is AI's core role in the labor force one of replacement or empowerment? This will directly impact the employment goal in the Federal Reserve's dual mandate. Third, how will the technological dividends of AI be distributed? Will the economic benefits broadly diffuse to businesses, consumers, and workers, or be primarily concentrated among a few technology firms and capital holders? This would affect the future income distribution landscape and macroeconomic stability. The bank believes this further corroborates Waller's intention to promote reforms in the Federal Reserve's policy framework to adapt it to the new macro environment. Waller also mentioned that his initial communications with the leaders of five major working groups left him feeling encouraged, but he emphasized that the suggestions from these groups would be released later, and would not influence current policy decisions. Additionally, Waller reiterated his opposition to forward guidance. He stressed that if central banks overly rely on explicit commitments regarding future policy paths, it may weaken their flexibility in adjusting policies. He referred to this issue as the hall-of-mirrors problemthe market prices according to Federal Reserve policy signals, and the Federal Reserve in turn assesses economic conditions based on market reactions. In the long run, this would diminish the market's focus on real economic changes, which is detrimental to policy adjustments. In conclusion, the bank believes Wallers speech effectively accomplished the key tasks he needed to achieve at the Jackson Hole conference. Compared to his statements at the July FOMC press conference, the signals conveyed this time were clearer and more conducive to restoring the Federal Reserve's policy credibility. The current market is not lacking in liquidity; what it lacks is discipline and predictability in policy. As long as inflation can be timely contained, it would in fact be beneficial for the market in the medium term.