This Is What The Rate Cut Cycle Could Look Like

Episode Summary

Executive Summary: The episode centers on the Federal Reserve’s shift at Jackson Hole from inflation-fighting to labor-market protection, with Powell signaling imminent rate cuts. Guest Peter Williams argues September is a near certainty, with the key debate now being 25 vs. 50 basis points and what that choice reveals about the Fed’s reaction function, the likely pace of easing, and whether rate cuts will meaningfully support growth.

Main Topics: Powell’s Jackson Hole pivot to labor-market risk (Priority: 5/5): The hosts discuss how Powell’s speech marked a major change in tone: inflation is less of a concern, while further weakening in employment is now the Fed’s main worry. September rate cut debate: 25 bps vs. 50 bps (Priority: 5/5): Peter Williams argues a September cut is effectively locked in, with the main open question being the size of the first move and whether the Fed front-loads easing to manage downside risks. What history says about cut cycles (Priority: 4/5): Williams contrasts mid-cycle corrections with recessionary easing cycles, suggesting the current situation resembles a mid-cycle correction but with unusual structural conditions and a higher perceived neutral rate. Reaction function and forward guidance (Priority: 4/5): The conversation explores how a first 50-basis-point cut would signal a more dovish and proactive Fed path into 2025, while a 25-basis-point move would imply greater institutional caution. R-star / neutral rate in the background (Priority: 3/5): Although less fashionable, r-star remains relevant as a concept for judging restrictiveness, but Williams says it should not drive short-term policy decisions because it is too uncertain and slow-moving. Inflation risk is not gone, just deprioritized (Priority: 4/5): The discussion notes that inflation could reaccelerate in 2025-26, but that is not the central concern right now; the Fed is prioritizing immediate labor-market fragility over potential medium-term inflation. Will rate cuts transmit effectively? (Priority: 5/5): The hosts and guest debate whether lower rates will actually revive rate-sensitive sectors like housing and sentiment, or whether the easing cycle may have limited real-economy effect.

Key Arguments: Powell’s speech confirms the Fed is now more worried about labor-market weakness than inflation, so the policy focus has shifted decisively. A September cut is extremely likely; Williams also expects cuts in November and December unless the data changes materially. A 50-basis-point initial cut would imply either a notably weaker labor market or a more aggressively dovish reaction function. Historical cut cycles are usually either modest mid-cycle corrections or recession responses; the current situation looks more like a mid-cycle correction, but with unusual post-COVID conditions. R-star may still inform how restrictive policy is, but it should not be the main guide because it is unobservable and too uncertain for meeting-to-meeting decisions. The key near-term test is whether rate-sensitive spending—especially housing—rebounds as market rates fall. If the Fed has to reverse course later because inflation reheats, that is less costly than failing to respond to a genuine labor-market deterioration now.

Data Points: Jackson Hole rate-cut expectation: September cut is expected - Peter Williams says a September rate cut is effectively certain after Powell’s speech. Possible front-loaded easing: November and December cuts also likely - Williams says the Fed will probably keep cutting after September in most scenarios. Potential initial cut size: 25 or 50 basis points - The main near-term debate is the size of the first cut. Historical mid-cycle easing size: 75 to 100 basis points - Williams cites mid-cycle correction episodes as relatively modest cumulative easing cycles. Fed median long-run rate: 2.8% - Used as the Fed’s current median estimate of neutral/long-run policy rate. Core PCE comfort zone: 2.25% to 1.9% - Williams suggests people likely won’t distinguish much between these levels if the labor market is fine. Policy horizon: 6 to 12 months - He notes monetary policy typically affects macro data with a lag of this length. Past rate-cut cycle examples: 1995-1998 and 2018-2019 - Cited as examples of mid-cycle corrections rather than recession-driven easing.

Pivotal Quotes: "We don't want to see any more. We're good on, at this point, the risks to the labor market are what we're primarily concerned with." — Lisa Mateo / paraphrasing Powell in discussion: Used to capture Powell’s Jackson Hole shift toward labor-market protection over inflation vigilance. "They're going to cut in September." — Peter Williams: Williams states his base case that a September rate cut is effectively locked in. "If you see a 50 in September, realistically, you should expect that like the reaction function, at least through early 2025 is going to be relatively more dovish than otherwise." — Peter Williams: Explains how the size of the first cut signals the likely pace and bias of the broader easing cycle.

Implications: Markets should watch labor data, especially jobs and claims, as the key driver of Fed decisions. The first cut’s size will matter as a signal for 2025, and the real test will be whether lower rates revive rate-sensitive spending and housing.