Quick View: Yield curve steepens on Powell’s dovish tilt

On August 22, Fed Chair Jerome Powell delivered his annual address at the Kansas City Fed’s Jackson Hole Economic Policy Symposium.

Amid a tumultuous first half of 2025, laden with tariff announcements, a weakening labor market, and political pressure on the Fed Chair to lower interest rates, market participants were paying close attention to Powell’s speech to get some clarity on the Fed’s policy stance going forward.

Powell’s speech stood out to us both for what he said, and for what he did not say.

What Powell did say

First, the Fed Chair acknowledged that downside risks to employment have increased and that the labor market may not be as strong as what was communicated at the most-recent Federal Open Market Committee (FOMC) meeting in July. The market perceived this as very dovish.

Notably, he stated that, “While the labor market appears to be in balance, it is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers. This unusual situation suggests that downside risks to employment are rising.”

Second, Powell reiterated the Fed’s commitment to preventing tariffs from creating ongoing inflation. We do not interpret this statement as hawkish; rather, we believe it was important for Chair Powell to put a stake in the ground and confirm that the central bank would not forget its mandate of price stability.

This declaration serves to maintain the Fed’s credibility and keep inflation expectations under control, which we believe will give the central bank the flexibility to lower rates in the future if needed.

Third, the Fed Chair unequivocally confirmed the central bank’s independence despite political pressure, stating that the board would remain data dependent and focused on its dual mandate of price stability and full employment in its decision-making process. His closing words – “we will never deviate from that approach” – provided a resounding full stop on the matter.

Finally, he prepared the market for potential noise in the inflation numbers in the coming months. He noted that, “Of course, “one-time” does not necessarily mean “all at once” and so it will take time for tariff increases to work their way through supply chains and distribution networks. Moreover, tariff rates continue to evolve, potentially prolonging the adjustment process.”

We agree with most Fed speakers that a reasonable base case is that tariffs will continue to place upward pressure on prices but that the effects will not cause an ongoing increase in inflationary pressures. 

In our view, the noise will make it harder for everyone (including the FOMC) to evaluate the data. It will also increase the probability that noisy inflation numbers may result in overreactions from both media and market participants.

What Powell did not say 

First, the Fed Chair did not commit to cutting rates, even though the tone of his speech was more dovish than initially anticipated. As previously mentioned, Powell maintained that the central bank would remain data dependent, thereby giving the board flexibility to stay on hold should labor data and inflation come in hotter than expected.

Second, while Powell did acknowledge that the policy rate is currently restrictive, he did not provide any color on how restrictive the board considers it to be. Notably, he did not discuss the neutral rate, other than stating the obvious – that, following 100 bps of rate cuts since this time last year, the central bank is less restrictive than it was a year ago.

Finally, he did not talk about the path of policy beyond the first cut. Once again, “data-dependent” would likely be the answer to this question, and the Fed would probably remain cautious in its approach following the first cut. As such, we do not believe the first cut would automatically open the door to a slew of subsequent cuts unless future data releases supported it.

Rate cut expectations

Our base case is that the Fed is likely to cut rates by 25 bps when it meets again on 16-17 September.

Granted, several economic data releases are due to be released before the next FOMC meeting, which could change things. But, in our view, the bar is pretty high for the Fed to deviate from this path.

We think there would need to be a strong rebound in the labor market when the Bureau of Labor Statistics (BLS) releases payrolls numbers on 5 September, combined with inflation staying at or above the current level, to stop the Fed from cutting in September.

Conversely, we think the odds of a larger 50 bps cut are extremely low. In our view, it would take a very bad payroll report to justify this course of action.

Implications for investors

Following Powell’s speech, the yield curve steepened, with short-term Treasury yields falling to a greater degree than long-term yields.

With the labor market softening, we think the short end of the yield curve continues to look attractive and appears better positioned to benefit from future rate cuts. The short end is also shielded from potential increases in term premiums on the long end if there are increased concerns over higher fiscal deficits or Fed independence. In essence, we believe the front end of the curve will serve as a better hedge if the economy weakens.

From a credit risk perspective, we still believe the economy remains on solid footing, and investors can lean into the attractive yields on offer, particularly in securitized sectors and within pockets of the corporate sector. While there is a risk that credit spreads may pull back if the next labor report comes in weak, we think that over time, risk assets are likely to bounce back as the market digests the Fed’s willingness to cut aggressively if needed. Additionally, we would expect yields to rally in this scenario, which would counterbalance any spread widening.

IMPORTANT INFORMATION

Fixed income securities are subject to interest rate, inflation, credit and default risk.  The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa.  The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

Securitized products, such as mortgage-backed securities and asset-backed securities, are more sensitive to interest rate changes, have extension and prepayment risk, and are subject to more credit, valuation and liquidity risk than other fixed-income securities.