Why Fed bets were so out of whack: Waller explains what put him 'over the edge' for a jumbo rate cut

By Greg Robb

Inflation might actually fall too far, the Fed governor says, opening the door wider for more half-point interest-rate cuts

Federal Reserve Governor Christopher Waller said Friday that it was the August inflation data released during the Fed's blackout period - and not concerns over a weakening labor market - that convinced him to back a more aggressive half-percentage-point interest-rate cut this week.

Most economists had expected the Fed to lower rates by 25 basis points at this week's meeting in part because Waller, in a speech right before the Fed stopped communicating ahead of the decision, said he wanted to start cutting rates "carefully" unless further data convinced him to move more forcefully.

Going into Wednesday's decision, analysts at Bank of America said that the degree of uncertainty expressed by markets about the Fed's path was the highest they had seen dating back to at least 2015.

The Fed stops communicating publicly 10 days before a policy decision. This month, the August consumer-price index data was released during this "blackout period." Economists predicted the higher core-inflation reading derailed the chances of 50-basis-point cut.

But Waller said the producer-price index data for August, released the next day, suggested that the core measure of the Fed's preferred personal-consumption expenditures index will run under a 1.8% annual rate over the last four months.

"Everybody was focused on core CPI, but what they weren't, really, was looking at how that CPI report and the next day's PPI report were going to feed into total core PCE inflation," Waller said in an interview with CNBC.

The two reports showed him that "inflation is softening much faster than I thought it was going to. And that is what put me over the edge to say, look, 50 is the right thing to do," he said.

Waller added that economic growth is fine, the labor market is solid and the half-point cut was not done out of a concern that the Fed was "falling behind the curve" and seeing the economy weakening too much as it kept interest rates too high.

In fact, "what's got me concerned is inflation is running softer than I thought," Waller said, noting that he doesn't want inflation to get too low.

While many in the public wouldn't mind low inflation, the Fed doesn't like to see inflation fall into negative territory. That's because deflation can be as damaging as high inflation to an economy, causing consumers to stop spending.

Some economists on Friday were skeptical over Waller's argument.

"The more convincing story is that the slowdown in job growth since the spring has spooked policymakers," said Jeffery Cleveland, chief economist at Payden & Rygel in Los Angeles.

In the CNBC interview, Waller laid out several scenarios for the size and pace of the next interest-rate cuts, saying that the data would ultimately decide what the central bank will do.

If the "data come in fine," Waller said he could imagine the Fed cutting its policy interest rate in two quarter-point moves at its meetings in November and December.

If the labor market worsens, or if inflation softens at a surprising rate, Waller said he could see "going at a faster pace" and possibly moving by 50 basis points.

And thirdly, if inflation suddenly reverses course and moves higher, the Fed would simply pause, he added.

Economists said that Waller opened the door wider for another 50-basis-point cut in November.

Before his remarks, the market was going to get its clues about the size of the next rate cut from the two jobs reports before the Fed's next meeting on Nov. 6-7.

Now that Waller has added inflation data to the mix, it makes another 50-basis-point cut "even more plausible," said Kevin Burgett, an economist at LH Meyer/ Monetary Policy Analytics, in an interview.

Krishna Guha, vice chairman of Evercore ISI, agreed. "The remarks from Waller - who many thought would be a reluctant 50 but sounded instead like a conviction 50 - reinforce our own assessment the bar to another 50 in November or a subsequent meeting is much lower" than the Fed suggested in its economic forecast released on Wednesday, Guha said.

The Fed's "dot plot" showed that 10 Fed officials projected two more quarter-point cuts by the end of the year, while 9 officials forecast one more cut.

-Greg Robb

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09-21-24 0726ET

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