On December 2, Monday, Eastern Time, Christopher Waller, a "high-profile" 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), expressing personal views on the Federal Reserve's monetary policy and the state of the USA's economy.

Key points of the speech:

Based on the current economic data, leaning towards supporting an interest rate cut at the December meeting, but this decision will depend on whether the data received beforehand unexpectedly rises and alters the inflation path forecast.

Interest rates are expected to 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 rate-sensitive industries and other businesses less affected by 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 composite indicators, such as the unemployment rate, suggest that the labor market remains healthy.

After significant progress in the past year and a half, recent data indicates that progress in reducing inflation may be stagnating.

Attention will be closely paid to 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, the committee is likely to skip rate cuts multiple times in the process of achieving this goal.

The speed and timing of interest rate cuts will be determined by the economic conditions encountered along the way, with the labor market reaching equilibrium, and the current policy still having restrictive support for the Federal Reserve to continue cutting rates.

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

Tendency to continue lowering rates in December, unless there are changes in inflation.

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

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

However, recent data shows that progress on inflation may stagnate at significantly above the 2% level. This risk raises concerns that the Federal Open Market Committee should consider maintaining the policy interest 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, there is a tendency to support a rate cut at the December meeting. However, this decision will depend on whether the data received before then unexpectedly trends upward, altering the 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 a slight slowdown in growth for the fourth quarter. The average forecast from the private sector is 2.2%, while based on currently limited data, the Atlanta Fed's GDPNow model predicts 3.2%.

In terms of consumer spending, real personal consumption expenditures (PCE) increased by 0.5% in September and grew by 0.1% in October. Given the recent volatility of these numbers, excessive interpretation of monthly fluctuations is not warranted. The moderate growth in October may partially reflect some pullback from the strong growth in September. Overall, household balance sheets remain in good condition, which should help sustain future spending.

On the business front, the S&P Global US Manufacturing Purchasing Managers' Index (PMI) edged up slightly in November but remained at a level indicating a slight deterioration in overall business conditions for manufacturers for the fifth consecutive month. Today's manufacturing survey by the Institute for Supply Management also showed a similar trend. These data align with ongoing industrial production data in manufacturing, which has been the case for several months.

However, these overall data mask a stark contrast in performance between interest rate-sensitive industries and other businesses that are less affected by interest rates.

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

For me, this divergence indicates that even after the committee has cut interest rates by 75 basis points, restrictive policies are still functioning as expected and affecting the production of interest-sensitive industries. It also reminds us that there is still some way to go before bringing the policy interest rate down to neutral levels. As interest rates decline, a narrowing of the gap between these two types of industries is anticipated. Regarding the service industry, which constitutes a large share of business activity, the S&P Global USA PMI continued to rise in November, extending the strong momentum of the service industry observed over the past year or two.

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

While the main economic data currently under our focus presents a rather clear picture of economic activity, recent data on the labor market is less clear.

As expected, the employment report for October shows little increase in employment, possibly due to the temporary effects of recent hurricanes and the strike at Boeing, 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, a rebound in the payroll data from the November employment report to be released later this week is indeed anticipated, but the overall volatility of the payroll data may take more time to fully resolve.

For this reason, there is a tendency to rely on other indicators to reveal the true state of the labor market. When reviewing broader data, the past year's data demonstrates a persistent slowdown in demand relative to supply, which aligns with inflation continuing toward the 2% target without any adverse softening in the labor market.

The unemployment rate began at 3.7% at the beginning of 2024, gradually rising, briefly touching 4.3%, before retreating to 4.1% in September and October. While still historically low, this indicates that the labor market is much looser compared to mid-2022 to mid-2023, when the unemployment rate was close to 3.5% and rapid wage growth contributed to high inflation.

Other data further highlights this loose but 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 decrease, which is another sign of the demand slowing relative to supply, but the number of layoffs remains low, aligning with a healthy labor market.

While labor productivity is growing strongly, the growth of wages and other forms of compensation has slowed. This is in stark contrast to a few years ago; for instance, in 2022, average hourly wages grew at an annual rate exceeding 5%, while worker productivity declined. This dual blow exerted immense upward pressure on inflation. However, in the second and third quarters of 2024, the annual growth rate of average hourly wages fell below 4%, while productivity grew by about 2%. The calculation is straightforward—4% wage growth minus 2% productivity growth means that wage growth is consistent with the goal of reducing inflation to 2%.

The progress of reducing inflation may be 'stagnating'.

While satisfied with the labor market's performance under restrictive monetary policy, the information conveyed by inflation data over the past few months is less satisfactory. After significant progress over the past year and a half, recent data suggest that progress may have stalled.

The inflation rate measured by the personal consumption expenditures price index from the USA Department of Commerce exceeded expectations in September and October, as did the 'core' personal consumption expenditures inflation rate (excluding the volatile prices of food and energy). Over the past two months, the annualized core personal consumption expenditures inflation rate for three months has increased, 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 resulted in a 12-month core personal consumption expenditures inflation rate of 2.8% in October.

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

Overall, I feel like a mixed martial artist, trying to keep inflation under control and waiting for it to submit, but it keeps escaping at the last moment. However, I assure you that inflation will ultimately yield— it cannot escape this 'octagon'.

While the recent rise in inflation and its levels have raised concerns that it may remain above the Federal Open Market Committee's 2% target, it's important to emphasize that this is a risk, but not a certainty.

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

Multiple factors support continued interest rate cuts, but the process will not be 'smooth sailing'.

Now, based on the assessment of the potential economic outlook, let's discuss the impact of monetary policy.

Although some recent aspects of the outlook may be a bit unclear, it is clear that the direction of monetary policy and the trend of our policy interest rate in the medium term will be 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 the spending and labor market data. Inflation has also significantly decreased during the same period, making it reasonable to shift the policy interest rate towards a more neutral environment.

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

The motivation for the Federal Open Market Committee to continue cutting interest 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 a further rate cut simply means we are not pressing the brakes as hard. Although monthly data on core inflation has stabilized in recent months, there are no signs that the price increases in key service categories like housing and non-market services should remain at current levels or rise.

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

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

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

Due to the impact of strikes and hurricanes, recent labor market data has left us confused about the true state of the labor market, which will not become clearer for months. Therefore, some may argue not to change the policy interest rate at the upcoming meeting and to adjust our policy stance moderately in the future. In fact, if policymakers' estimates of the target range by the end of next year are close to being correct, the committee is likely to skip rate cuts multiple times in the process of achieving that goal.

I will closely monitor more data when deciding which approach to take at the next meeting of the Federal Open Market Committee.

Tomorrow, we will receive data from the Labor Department's job openings and labor turnover survey. On Friday, we will receive the employment report, which, as I have pointed out, may have misleading payroll data. Next week, we will get the consumer and producer price indices for November, which will help in estimating 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 determine whether to cut interest rates or skip.

As of today, I lean towards continuing the work we have already started to restore monetary policy to a more neutral environment. The policy remains sufficiently restrictive such that another interest rate cut at the next meeting would not significantly change the monetary policy stance, and if necessary, there is enough room to slow the pace of interest rate cuts later to maintain progress towards the inflation target. That is to say, if unexpected data emerges from today until the next meeting indicating that our forecast for inflation to slow and the economy to slow while remaining robust is incorrect, then I would support holding the policy rate steady. In the coming weeks, I will closely monitor the upcoming data to help me decide which path to take.

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