– Inflation And Monetary Policy Are ‘At A Crossroads’
– Economy Solid’, Employment ‘Stable’; So, Focus Must Be on 2% Inflation Target
By Steven K. Beckner
(MaceNews) – On the eve of a critical inflation report, Federal Reserve Governor Christopher Waller declared Monday that a bad reading could necessitate an early Fed interest rate hike.
Waller, who not long ago was thought of as being one of the more dovish Fed policymakers, instead took a very hawkish perspective in remarks to the New York Association for Business Economics.
Describing himself as “concerned about the elevated pace of core inflation,” he said, “inflation and monetary policy are at a crossroads” with the July 28-29 meeting of the Fed’s rate-setting Federal Open Market Committee rapidly approaching.
With the economy enjoying “solid” growth and labor markets “stable,” Waller said the Fed’s focus has to be on inflation, which has exceeded the Fed’s 2% target for going on six years.
Delaying action against inflation could risk a further acceleration of inflation, as well as a deterioration of inflation expectations that would make inflation even harder to rein in, he cautioned.
On Tuesday morning, the Labor Department will be releasing its consumer price index for June, and Waller warned, “If we get another hot reading on core inflation … then the FOMC will need to consider tightening monetary policy in the near term.”
The June CPI report, which will be released ahead of congressional testimony by Chair Kevin Warsh on the Fed’s semi-annual Monetary Policy Report, is less important than the Commerce Department’s price index for personal consumption expenditures (PCE), but will still get a close, extrapolating look on Wall Street and at the Fed.
Some are hoping for a softer result than in May, when the CPI increased 0.5% for the month and 4.2% from a year earlier. The core CPI, excluding volatile food and energy prices, was up 0.2% on the month and 2.9% on year.
The CPI, as well as Wednesday’s Producer Price Index, will be used to calculate estimates of the PCE inflation rate for June. In May the PCE registered 4.1% overall and 3.4% on a core basis from a year earlier.
The FOMC has held the key federal funds rate in a target range of 3.5% to 3.75% since it concluded a series of rate cuts totaling 100 basis points in December, but at its June 17 meeting, FOMC participants projected the funds rate will need to rise by 25 basis points by the end of the year to a median 3.8% (3.75% to 4.0%) as they significantly boosted their inflation forecasts.
A bad inflation reading this week could force the FOMC to begin raising rates as soon as the late July meeting, implied Waller, who not long ago was an advocate of rate cuts when he was competing with Waller for the Fed chairmanship.
He said the FOMC cannot afford to merely “look through” energy price hikes, assuming they will recede, because core inflation has also been stubbornly high.
“Because core inflation is a good guide to future inflation,” he said. “I am concerned that, if this upward trend continues, it will be hard to push inflation back toward the Committee’s 2% goal with monetary policy at its current setting.”
Waller recalled “the mistake we made in 2021 by not responding sooner to the high inflation we observed,” and said he is “determined to avoid repeating it.”
He allowed for the possibility that the FOMC won’t have to raise rates, saying, “there is still a credible case for inflation to begin to fall back to our 2% goal with policy at its current setting.”
“But,” he added, “I am concerned about the equally plausible case that data in the coming weeks will show that inflation will remain at its elevated level or even trend higher, requiring tighter monetary policy in the near term.”
While “committed to returning inflation to the FOMC’s 2% goal,” Waller said he is “also determined to avoid over tightening policy and risking a recession.”
But he went on to suggest that recession is now the least of the Fed’s worries.
“Economic activity continues to be solid…,” he said. “(S)pending appears to have held up reasonably well. At the same time, businesses continued to make investments related to artificial intelligence (AI).”
What’s more, downward risks to the Fed’s “maximum employment” mandate are few, Waller indicated. “
Together, “(A)though there has been some noise in the labor market data recently, I believe the story there is one of stability and a balance between supply and demand…..Other data in recent months support the idea that the labor market is stable and balanced.”
And so, Waller asserted, “Unless I see evidence of a significantly weakening labor market, my focus will be on inflation.”
While surging energy costs have driven up overall price indices, “more concerning is the escalation in core inflation, which, at a 12-month rate of 3.4% in May, was more than 0.5 percentage point higher than last October,” he said, adding that these core price pressures are “quite broad.”
“Sometimes a big change in only one component of core prices can move the total significantly without reflecting broader pressures from escalating inflation, but that doesn’t appear to be the case this time,’ he elaborated. “Both core goods prices and core services inflation are up relative to last year. And, they stand well above their averages at times when inflation was running persistently close to 2% percent, such as the six years from 2002 through 2007.”
Waller, who was speaking just as a flare-up in tensions with Iran was pushing oil prices back up, said, “I do expect a deceleration of headline inflation due to declining oil prices, starting with the inflation data we get this week.”
But he reiterated, “I will be focused on core inflation, and on that count, there are recent signs of continued pressure on goods prices.”
Waller attributed upward pressures on core inflation to three factors: tariffs, energy prices, and “spillovers from demand for the AI build-out.”
Regarding the latter, he said AI-related demand “is being reflected in some large price increases on selected goods such as semiconductors, computer chips, servers, computers, and peripherals.” He said those price pressures “could be a larger factor if the investment surge for AI continues.”
The FOMC must be ready to respond, possibly in coming weeks, Waller argued.
“Overall, I am monitoring price movements and am alert to the risk that the increase in core inflation is a sign that inflationary pressures are spreading through the economy,” he said. “The FOMC has to be ready to tighten monetary policy to prevent a repeat of the 2021-to-2022 inflation episode.”
Nevertheless, Waller described himself as “cautious” about raising rates as steeply as it did then because of two factors: “The first is that today’s labor market isn’t nearly as tight…..Another difference with 2022 is that inflation expectations today seem well anchored.”
But he said those who maintain “anchored” inflation expectations allow the Fed to avoid raising rates are “wrong,” although he said rate hikes may have to be “less persistent.”
“In this situation, the central bank only faces one problem—getting inflation back to target,’ Waller declared.
During previous inflation periods, when inflation expectations were less “anchored,” the Fed had to raise rates aggressively, he recalled.
“Thankfully, we are not in this position today,” he said. “But it does not mean we can be lackadaisical in responding to inflation that is well above target and headed in the wrong direction.”
Looking ahead to the CPI and PPI reports, Waller said he “would be very pleased to see a lower reading on core inflation, but after its escalation over the first half of this year, I will need to see several months of lower readings to feel that inflation is moving in the right direction…..”
“I think that is still a reasonable outcome, and I would then continue to hold the policy rate at its current target range,” he continued.
“But,” he added, “If we get another hot reading on core inflation this week, then the FOMC will need to consider tightening monetary policy in the near term.”