Waller on a hawkish Fed: what would trigger a September hike

The news

Federal Reserve Governor Christopher Waller laid out on September 3 the conditions under which he would back holding rates or raising them when the FOMC meets September 15-16. Speaking at a Reuters NEXT newsmaker interview in Washington, he described how a hawkish Fed turn would hinge largely on one data point: August inflation.

Key takeaways:

• If data due over the next two weeks keep showing disinflation, Waller said he would be inclined to support holding the federal funds rate at its current setting.
• If August data show the improvement was fleeting, he said it may be appropriate to raise the rate on September 15-16.
• He judges policy to be only slightly restricting demand, so it may not take much of an inflation acceleration to tip him toward tighter policy.
• He also used the speech to explain how he communicates his “reaction function” to the public.

Our analysis

Waller’s economic description is the backdrop for the conditional message. Real GDP grew at a 1.8 percent annual rate in the first half of the year, while real private domestic final purchases rose 3 percent. Job creation has averaged 60,000 a month through July, which he regards as close to or a bit above the pace needed to keep up with slow labor force growth, given much lower net immigration. The unemployment rate fell to 4.1 percent in July. He described growth as solid and the labor market as in satisfactory shape, and said neither is a large factor in his policy judgment.

Inflation is the focus. PCE prices rose 0.2 percent in July, with core up 0.2 percent. Over twelve months, PCE inflation is 3.7 percent and core is 3.3 percent. Waller argued that the twelve-month figures are a poor guide to where inflation stands now, and pointed to three-month core inflation of 3.05 percent through July, down steadily from 4.76 percent in February. He also noted that nonmarket services prices, which are imputed rather than observed, accounted for roughly half of the July rise in core prices, and said that ignoring that factor, underlying inflation looks better than the headline core number.

He sees tariff effects as having largely passed through and said his earlier worry about energy costs spreading into other prices has not materialized so far. Risks he listed on the upside include energy prices that have moved up again, pressure on technology goods prices from the AI buildout and possible tariff increases. He added that the Fed should be prepared to act if longer-term inflation expectations rise and progress on inflation reverses.

The second half of the speech is a lesson in how to read Fed speakers. Waller distinguishes three kinds of communication: explaining why a vote was cast, describing a reaction function, and giving forward guidance. His reaction function is a conditional statement: if the data come in a given way, he will advocate a given policy. He compared it to an umpire’s strike zone, which players need to know roughly but which does not have to be perfect. He said he agrees with Chairman Warsh that forward guidance is not appropriate now, reserving it for conditions such as a policy rate at the effective lower bound.

For investors and households, the practical result is a clear map. Between now and the meeting, the August inflation figures are the swing factor, and the FOMC statement that follows will show which branch the Committee took.

Room for disagreement

Waller’s discounting of nonmarket services prices is a judgment call, and he acknowledged it: he said he does not like removing specific categories from the PCE estimate in general. Colleagues who prefer the headline core measure could read the same July data as showing less progress than he does. Twelve-month core at 3.3 percent is well above the 2 percent goal, and he conceded that three-month inflation of 3.05 percent is still inconsistent with the goal.

There is a second tension. He argued that policy is only slightly restrictive, which supports the case for a hike if inflation re-accelerates. Someone who sees policy as already restrictive after a long hold would weigh the same data differently. His remarks also treat a pending Commerce Department change to how fees paid to stock market traders and related professionals are estimated as a likely source of lower reported inflation, which adds to the uncertainty about what the August number will show.

What to watch

• The August employment report on September 4 and the August inflation data due before the meeting.
• The FOMC statement on September 16 and whether the Committee’s language on inflation changes.
• The new quarterly projections released with the statement, where participants’ policy views are tallied.
• Whether other FOMC participants echo Waller’s conditional framing in their remarks before the meeting.