(Reuters) - Investors cheered Federal Reserve Chair Jerome Powell's Jackson Hole address, which gave a green light to buy risky assets on the hope the central bank is ready to cut rates, but took his dovish message with a note of caution as they see a risk of stagflation ahead and worry markets are over-optimistic.

In his final address as Fed chair at the Jackson Hole, Wyoming, economic symposium, Powell hinted at a September interest rate cut but stopped short of committing, striking a careful balance between mounting job-market risks and lingering inflation worries.

The speech on Friday came amid mounting pressure from the White House to ease monetary policy, which has raised market concerns that political influence will lead the U.S. central bank to become too aggressive in cutting rates in the future.

"Powell definitely locked in that September rate cut and the certainty of that is rippling in a positive way across global markets," said Matthew Miskin, co-chief investment strategist at Manulife John Hancock Investments. "This still leaves, what happens after September? And I think that's where the markets are getting ahead of themselves," he said.

The Jackson Hole address followed a weak July jobs report and significant downward revisions to earlier job figures that fueled bets the U.S. central bank will cut interest rates later this year from the current 4.25%-4.5% range.

Those expectations, however, lost steam in recent weeks as a surge in wholesale prices in July fueled concerns that stubbornly high inflation would limit the Fed's ability to come to the market's rescue with hefty rate cuts.

"People have been increasingly worried that we're kind of heading into a stagflationary story," said Drew Matus, chief market strategist at Metlife Investment Management, referring to a worrying mix of sluggish growth and relentless inflation.

Matus added that investors were expecting inflation would "stick around for a little bit," but said the real question remains over how much the economy can grow.

"I think we're going to get some growth, but it's not going to feel great," said Matus.

Investors also noted that more data on inflation and the labor market are due ahead of the Fed's next meeting and could factor into rate decisions, potentially stalling any rally.

"Looking over the next couple months, rate cuts alone won't be enough to sustain strength in stocks," said Tom Graff, chief investment officer at Facet. "If in fact the economy is stalling and the labor market continues to deteriorate, there are risks to this equity market rally.”

RATE CUT BETS

Others in the market said optimism was warranted.

"If the Fed is going to move here and cut rates gradually and take their foot off the brake a little bit for the economy, I think it makes perfect sense that we're seeing a rebound," said Paul Eitelman, global chief investment strategist at Russell Investments.

Rates futures traders assigned a 70% probability to a quarter-point interest rate cut in September ahead of Powell's speech. Late on Friday that stood at 80%, LSEG data showed.

Rate-sensitive two-year U.S. Treasury yields dropped by about 10 basis points to 3.69%. Benchmark 10-year yields were down nearly eight basis points to 4.26%. Yields move inversely to prices.

Wall Street's main indexes ended higher on Friday, with the blue-chip Dow hitting a record closing high. The S&P 500 gained 1.47% on the day, hovering near record high levels. Rate-sensitive stocks gained. Small caps, which typically rely on borrowing to fund their growth, surged, with the small-cap Russell 2000 rising 3.8%. Homebuilding shares also jumped, with the PHLX housing index up 4.6%.

Powell's comments are "music to the market's ears," said Angelo Kourkafas, senior investment strategist at Edward Jones in St. Louis. "The fact that we are still looking for easing ahead provides some comfort that at least the elevated (equity) valuations and expectations are supported by the fact that we're looking at looser policy," he said.

FED INDEPENDENCE CONCERNS

Powell's address, however, sent the dollar sharply lower on concerns over a slowing economy, with worries around the independence of the Federal Reserve compounding the selloff.

Lower interest rates can make the dollar less attractive to investors who may seek better returns in other currencies, reducing the demand for the greenback. The dollar index , which measures the greenback against a basket of currencies including the yen and the euro, was last down 1%.

"Rate differentials are tilting against the dollar," said Karl Schamotta, chief market strategist at Corpay, adding traders were positioning for "asymmetric upside outside the U.S."

The speech, Powell's final one as chair with his term ending in May, comes after relentless pressure from U.S. President Donald Trump on Powell to cut interest rates. Powell reiterated on Friday that Fed policy will remain strictly data-driven, never deviating from that approach.

The pressures, however, ratcheted up earlier this week after Trump urged Fed Governor Lisa Cook to resign, a move that could allow him to appoint more dovish members to the Fed's rate-setting Federal Open Market Committee. On Friday, Trump said he would fire Cook if she doesn't resign following allegations over her mortgage loans.

"Trump's words on Cook ... are once again raising concerns over the Fed's independence," said Helen Given, director of trading, Monex USA, Washington.

Posted by: AAngeles