Full text of "Hot Ticket Committee" Waller's speech: Whether to lower in December depends on inflation, but a continued decline in medium-term interest rates is clear

On December 2nd, Eastern Time, Christopher Waller, a voting member of the Federal Reserve and a long-time member of the Federal Open Market Committee (FOMC), spoke at a monetary policy forum hosted by the American Institute for Economic Research (AIER), sharing his personal views on the Federal Reserve's monetary policy and the state of the U.S. economy.

The key points of his speech are as follows:

Based on the current economic data at hand, I am inclined to support a rate cut at the December meeting, but this decision will depend on whether the data received before then unexpectedly rises and alters my inflation path forecast.

I expect that interest rates will continue to decline over the next year until the policy rate approaches a more neutral level.

Overall data masks the starkly different performances between interest-sensitive sectors and other businesses less affected by interest rates. Even with a 75 basis point rate cut, restrictive policies are still in effect.

Non-farm payrolls have fluctuated significantly and can no longer fully reflect the state of the labor market. Other comprehensive indicators, such as the unemployment rate, suggest that the labor market remains healthy at present.

After significant progress over the past year and a half, recent data indicate that progress in reducing inflation may have stalled.

I will closely monitor the upcoming employment and inflation data. Even if the process of declining inflation slows, the overall economic health suggests that the Federal Reserve is suitable to continue easing monetary policy.

If policymakers' estimates for the target range by the end of next year are close to correct, then the committee is likely to skip rate cuts multiple times in the process of achieving this goal.

The full text of the speech, translated by AI, is as follows:

Inclined to continue rate cuts in December unless inflation changes

Thank you, Lydia, for the opportunity to speak today. I would like to take this time to discuss the ongoing efforts of the Federal Open Market Committee (FOMC) to restore the inflation rate to the 2% target while maintaining a strong labor market and economy.

After making significant progress in reducing inflation and a noticeable slowdown in the labor market, the committee determined in September that as the inflation rate moves toward the 2% target, it is time to shift monetary policy toward a more neutral environment to reduce the risk of excessive weakness in the labor market. Since the September meeting, we have lowered the policy rate by 75 basis points, and I believe that monetary policy remains restrictive, applying downward pressure on inflation without adversely affecting the labor market. I expect that interest rates will continue to decline over the next year until the policy rate approaches a more neutral level.

However, recent data indicate that progress in inflation may be stalling at levels significantly above 2%. This risk raises concerns that the Federal Open Market Committee should consider maintaining the policy rate at the upcoming meeting to gather more information about the future trends of inflation and the economy.

Based on the current economic data at hand, and forecasts indicating that the inflation rate will continue to decline to 2% in the medium term, I am currently inclined to support a rate cut at the December meeting. However, this decision will depend on whether the data received before then unexpectedly rises and alters my inflation path forecast.**

Even with a 75 basis point rate cut, restrictive policies are still in effect

In the third quarter of 2024, real Gross Domestic Product (GDP) grew at a strong annual rate of 2.8%, with signs indicating that growth will slightly slow in the fourth quarter. The average forecast from the private sector is 2.2%, while the Atlanta Fed's GDPNow model currently predicts 3.2% based on relatively limited data.

In terms of consumption, real Personal Consumption Expenditures (PCE) grew by 0.5% in September and by 0.1% in October. Given the recent volatility of these numbers, I would not overinterpret the monthly fluctuations. The moderate growth in October may partially reflect some pullback from the strong growth in September. Overall, household balance sheets remain in good shape, which should help sustain future spending.

On the corporate side, the S&P Global U.S. Manufacturing Purchasing Managers' Index (PMI) slightly increased in November but remains at a level indicating a slight deterioration in overall business conditions for manufacturers for the fifth consecutive month. Today's Institute for Supply Management manufacturing survey shows a similar trend. These data align with the industrial production data for manufacturing, which has been consistent over the past few months.

However, these overall figures mask the starkly different performances between interest rate-sensitive sectors and other sectors less affected by interest rates.

In the spring of 2022, when the Federal Open Market Committee began raising rates, the output growth of interest rate-sensitive manufacturers (such as commercial equipment manufacturers) was roughly on par with that of less interest rate-sensitive manufacturers. But around mid-2023, when policy rates peaked, a divergence occurred, with output in interest rate-sensitive manufacturing declining while output in other manufacturing increased, leading to a significant gap between the two sectors.

For me, this divergence indicates that even after a 75 basis point rate cut, restrictive policies are still functioning as expected, impacting production in interest rate-sensitive sectors. It also reminds us that there is still a way to go before bringing policy rates down to neutral levels. As rates decline, I expect the gap between these two sectors to narrow. As for the services sector, which accounts for a large share of commercial activity, the S&P Global U.S. PMI continued to rise in November, extending the strong momentum in services over the past year or two.

Non-farm data can no longer fully reflect the labor market situation

While the major economic data we are currently focused on presents a fairly clear picture of economic activity, the recent data on the labor market is less clear.

As expected, the October employment report showed little change in employment numbers, likely due to the temporary effects of recent hurricanes and the Boeing strike, which also affected businesses serving Boeing and its employees. The strike has ended, and most of the unemployment caused by the hurricanes may have been restored. Therefore, I do expect a rebound in the payroll data in the November employment report to be released later this week, but the overall volatility in payroll data may take more time to fully resolve.For this reason, I tend to rely on other indicators to reveal the true state of the labor market. When I look at broader data, the figures from the past year show a continued slowdown in demand relative to supply, which aligns with inflation steadily moving towards the 2% target without any signs of significant weakness in the labor market.

The unemployment rate was 3.7% at the beginning of 2024, gradually rising, briefly touching 4.3%, and then falling back to 4.1% in September and October. Although still low from a historical perspective, this indicates that the labor market is much looser than it was from mid-2022 to mid-2023, when the unemployment rate was close to 3.5% and rapid wage growth fueled high inflation.

Other data further highlights this loose yet still strong labor market. The proportion of workers voluntarily resigning (an indicator of labor market tightness) has fallen below pre-pandemic levels. The number of job vacancies continues to gradually decline, which is another sign of slowing demand relative to supply, but layoffs remain low, consistent with a healthy labor market.

While labor productivity has grown strongly, wage and other forms of compensation growth have slowed. This is in stark contrast to a few years ago, for example, in 2022, average hourly wages grew at an annual rate of over 5%, while worker productivity was declining. This dual blow put significant upward pressure on inflation. However, in the second and third quarters of 2024, the annual growth rate of average hourly wages was below 4%, while productivity growth was about 2%. The calculation is simple—4% wage growth minus 2% productivity growth, means that wage growth is consistent with bringing inflation down to the 2% target.

Progress in Reducing Inflation May Be "Stalling"

While I am satisfied with the performance of the labor market under restrictive monetary policy, I am less pleased with the message conveyed by inflation data over the past few months. After significant progress over the past year and a half, recent data suggests that progress may be stalling.

The inflation rate measured by the U.S. Department of Commerce's Personal Consumption Expenditures Price Index saw increases in September and October that exceeded expectations, as did the "core" Personal Consumption Expenditures inflation rate (excluding volatile food and energy prices). Over the past two months, the three-month annualized core Personal Consumption Expenditures inflation rate has risen, while the six-month annualized inflation rate has only slightly improved. Currently, these two rates stand at 2.8% and 2.3%, respectively. This recent data led to a 12-month core Personal Consumption Expenditures inflation rate of 2.8% in October.

If we compare the core inflation components from October of this year to those from October of last year, we find that 12-month housing services inflation has eased, goods inflation has turned to slight deflation, but non-market core services excluding housing have increased.

Overall, I feel like a mixed martial artist, constantly grappling with inflation, waiting for it to submit, but it keeps slipping away at the last moment. But I assure you, inflation will ultimately yield—it cannot escape this "octagon."Although the recent rise in inflation and its level has raised concerns about the possibility of it staying above the Federal Open Market Committee's 2% target, I want to emphasize that this is a risk, but not a certainty.

I take the recent inflation data seriously, but we also saw a similar rise in inflation a year ago, followed by a continued decline in inflation, so I do not want to overreact. I expect housing services inflation to continue to moderate, and I do not place much importance on high inflation signals from other non-market services.

Multiple factors support continued rate cuts, but the process will not be "smooth sailing"

Now, based on my assessment of the potential economic outlook, let’s talk about the impact of monetary policy.

While some recent aspects of the outlook may be somewhat unclear, what is clear is the direction of monetary policy and the trajectory of our policy rate in the medium term, which is downward. This downward trajectory reflects the fact that total demand in the economy has significantly slowed relative to supply over the past year—this is clearly visible in spending and labor market data. Inflation has also significantly decreased during the same period, so it is reasonable to shift the policy rate toward a more neutral environment.

There is still a way to go. In September, the median forecast among Federal Open Market Committee participants was that the federal funds rate would be 3.4% by the end of next year, about 100 basis points lower than it is now. This number may and likely will change over time, but regardless of the destination, there will be multiple paths to get there, and the speed and timing of rate cuts will be determined by the economic conditions we encounter along the way.

The motivation for the Federal Open Market Committee to continue cutting rates at the next meeting primarily stems from the restrictive nature of the current policy setting. After we cut rates by 75 basis points, I believe there is ample evidence that the policy remains significantly restrictive, and another rate cut simply means we are not pressing the brakes as hard. Although the monthly data on core inflation has stabilized in recent months, there are no signs that the price increases in key service categories such as housing and non-market services should remain at current levels or rise.

Another factor supporting further rate cuts is that the labor market seems to have finally reached a balance, and we should strive to maintain this state.

Conversely, based on what we currently know, one might argue that there is reason to skip a rate cut at the next meeting.

Recent monthly inflation data has clearly risen, and we do not know whether this rise in inflation will persist or reverse as it did a year ago.

Due to the impacts of strikes and hurricanes, recent labor market data has left us confused about the true state of the labor market, and it may not become clearer for several months. Therefore, some may advocate for no change in the policy rate at the upcoming meeting and for a moderate adjustment of our policy stance in the future. In fact, if policymakers' estimates of the target range for the end of next year are close to correct, the committee is likely to skip rate cuts multiple times in the process of achieving that goal.

As the Federal Open Market Committee decides which approach to take at its next meeting, I will be closely monitoring more data.

Tomorrow, we will receive the Job Openings and Labor Turnover Survey data from the Department of Labor. **On Friday, we will receive the employment report, and as I pointed out, the payroll data in that report may be misleading** Next week, we will receive the Consumer and Producer Price Index for November, which will help to estimate the personal consumption expenditure inflation rate for the month. Finally, on the first day of the Federal Open Market Committee meeting, we will receive the retail sales data for November, which will give us insight into consumer spending.

All this information will help me decide whether to cut interest rates or skip.

As of today, I tend to continue the work we have already started to restore monetary policy to a more neutral environment. The policy remains sufficiently restrictive, so a further interest rate cut at the next meeting would not significantly change the monetary policy stance, and there is enough room to slow down the pace of rate cuts later if needed, to maintain progress towards the inflation target. That said, if unexpected data comes in from today until the next meeting indicating that our forecasts for slowing inflation and a robust but slowing economy are incorrect, then I would support keeping the policy rate unchanged. In the coming weeks, I will closely monitor the upcoming data to help me decide which path to take