Fed Governor Chris Waller: Still believe we need to cut rates, but need to be 'cautious about it'

Key Concepts

• Policy in the Dark: Making economic policy decisions in the absence of official government data.
• Private Sector Data: Non-governmental economic indicators used to gauge market conditions (e.g., ADP, Carlisle).
• BLS Data (Bureau of Labor Statistics): Official government data on employment and inflation (e.g., jobs report, CPI).
• CPI (Consumer Price Index): A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
• ADP Data (Automatic Data Processing): A private payroll processing firm that releases monthly employment reports.
• Labor Market Weakness: A condition characterized by negative job growth, lack of wage increases, and low vacancies.
• Maximum Employment & Price Stability (Dual Mandate): The two primary objectives of the Federal Reserve's monetary policy.
• Tariff Effects: The impact of import duties on prices and economic activity.
• Persistent Inflation: A sustained increase in the general price level of goods and services.
• One-Off Effects: Temporary or non-recurring price increases that do not lead to persistent inflation.
• Look Through: A central bank policy approach of disregarding temporary price fluctuations (like those from tariffs or taxes) when setting monetary policy.
• Wage-Price Spiral: A macroeconomic theory describing a vicious circle where rising wages lead to higher prices, which in turn lead to demands for even higher wages.
• Second-Round Effects: The subsequent, indirect impacts of an initial economic shock, such as tariffs leading to wage demands.
• GDP Growth (Gross Domestic Product): The total monetary or market value of all the finished goods and services produced within a country's borders in a specific time period.
• Rate Cuts: Reductions in the target interest rate set by a central bank.
• Systemic Risk: The risk of collapse of an entire financial system or market, as opposed to the collapse of a single entity.
• Private Credit Market: A non-bank lending sector that provides financing to companies, often involving direct lending from institutional investors.
• Equity Position: The ownership stake in a company, representing a claim on its assets and earnings.
• Highly Leveraged Lending: Lending to companies that already have a significant amount of debt relative to their equity.

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Interview Regarding Fed Chair Finalist Rumors

Governor Chris Waller addressed recent reports of him being a finalist for Fed Chair. He stated he was unsure if he was a finalist but described his interview as "great," "serious economic discussions," and "nothing political." He noted that the interview involved extensive discussion about various aspects of the Fed and his points of view from past speeches, with follow-ups on specific details.

Policy in the Absence of Economic Data ("Policy in the Dark")

Governor Waller discussed the challenge of making policy decisions when official government economic data, such as the CPI, is delayed or unavailable.

• Historical Precedent: He recalled a previous instance of data delays during a shutdown, where policymakers relied on private sector data.
• Methodology: In such situations, the Fed examines "a lot of private sector data" from various sources (e.g., Carlisle, ADP). While acknowledging that this data is "not necessarily representative or as broad as sort of the government official data," he emphasized that "if you get enough pieces of information, you can kind of pretty much get a picture of what's happening."
• Labor Market Assessment: Based on private sector and anecdotal evidence, Waller concluded that "the labor market is weak." He noted that "job growth has probably been negative the last few months," and anecdotal reports indicate companies are "not backfilling, not firing, holding off any job things." He would be "shocked" if official data showed 150,000 jobs a month, as it would contradict other information.
• High-Frequency Data (ADP): He acknowledged that ADP data isn't always strongly correlated with official figures but provides "some signal of what's going on," advocating to "use what you have when you have it."
• Importance of BLS CPI Data: Waller stressed the significance of receiving the BLS CPI data, calling it one of the "biggest concerns" for his colleagues regarding inflation. He also highlighted the importance of the BLS labor data, stating that these two points, combined with private sector information, provide a comprehensive picture.

Inflation Concerns and the Need for Rate Cuts

Governor Waller addressed the committee's division on further rate cuts, particularly concerning inflation data. He presented his perspective, which is less concerned about tariff-induced inflation.

• Tariffs and Inflation: Waller argued that tariffs cause "one off effects" and "one time increases in the price level," which "doesn't cause persistent inflation." He cited the long-standing central bank practice of "look[ing] through these types of things," referencing Canada's VAT tax in the 1990s as an example where they disregarded temporary price effects. He believes policy should not be set based on temporary inflation spikes that are expected to "come up and then come back down."
• Primary Concern: The Labor Market: His biggest concern is the labor market. He reiterated his view from June that "the labor market was not as good as it looked," a view he believes was confirmed by the August 1st jobs report.
• Labor Market's Role in Inflation: Waller explained that a tight, strongly growing labor market would be a source of inflation, making tariff effects more concerning. However, he sees no evidence of a tight labor market: "negative job growth, that's not maximum employment." There are no signals like "wages going up, vacancies would be going up" in either public or private data.
• Absence of Wage-Price Spiral: He dismissed fears of "second round knock on effect[s]" or "wage price spirals" from tariffs, stating, "That's not happening. We're not seeing any evidence of that whatsoever."
• Imported Goods Inflation: While a colleague, Stephen Myron, reportedly sees "almost any inflation, even in imported goods," Waller noted that inflation is seen in "various measures." He explained that businesses pass tariffs through to "higher income consumers" who are "very price insensitive," but not to the "lower half of the income distribution" to avoid losing customers, creating a "two tier way." He cited a "very clear correlation between the size of the tariff and the change in the price of those goods over the last six months," with "about a 40% pass through."

Future Policy Direction and Rate Cuts

Waller believes "we need to cut rates" but advocates for a cautious approach.

• Divergent Data: He highlighted a discrepancy between a "very weak labor market" and seemingly "pretty good" GDP growth (Fortt GDP now forecasting "close to 4%"). He stated, "Something's got to give either the labor market rebounds to match the GDP growth or that GDP GDP growth is going to pull back."
• Policy Adjustment: The direction of policy depends on how this divergence resolves: "If labor market rebounds and growth is good, there's less need for rate cuts. If the GDP comes down the labor market stays weak, you need more."
• Cautious Pacing: He advises against aggressive, fast rate cuts to avoid "a big mistake." While the market is "priced in for sequential cuts through the end of the year" (signaled by the S&P), he considers quarter-point cuts "cautious enough" because "you can always adjust as you go as the data comes in." He contrasted this with a hypothetical 75 basis point cut, which would be problematic if the bet was wrong.

Private Credit Market and Systemic Risk

Regarding the private credit market, a new "shadow lending industry," Governor Waller expressed limited concern about it being a potential source of systemic risk.

• Low Leverage: Based on his understanding (though not an expert), private credit involves "a lot of equity position" and is "not highly leveraged lending."
• Risk Mitigation: He noted that major banks involved typically take a "senior position," and there's "usually about 50% or more equity" in these deals. This substantial equity buffer means "a lot of equity that has to get eaten into before anybody gets defaulted on their thing."
• Conclusion: Therefore, he does "not view it as that big of a risk because there's so much equity." He concluded with a statement on capitalism: "People are going to lose money, but that's capitalism and it's not my job to protect your wealth. You want to take risk, it pays off. Good."