Fed Governor tempers expectations on US rate cuts

Federal Reserve Governor Christopher Waller gave a speech on November 28 titled: “Something Appears to Be Giving”, where he laid out the reasons why he is becoming more confident of the Fed’s ability to bring inflation down to its 2% target. 

After a number of hawkish comments from his peers (many of whom still pointed towards the possibility of further hikes), this was the dovish precursor to the Federal Open Market Committee (FOMC) conference where Fed Chair Jerome Powell essentially got the wheels moving on the cutting cycle. The market was eager, therefore, to hear updated thoughts from Governor Waller this week to see whether he was going to push back on the seven or so cuts that had been priced into markets for this year. 

This was especially interesting after a number of stronger-than-expected data prints since the December FOMC, including nonfarm payroll (216k), average hourly earnings (4.1% year-on-year), and CPI (0.3% month-on-month). Ultimately, the market to a certain degree has to avoid getting too fixated on the monthly “noise”. While nonfarm payroll was stronger than expected in December, as Governor Waller pointed out, there is a good chance this gets revised down in the January print (as most did last year), and, even with a 216k December print, the fourth quarter average of 165k was well below the 227k we saw in the third quarter, with a similar trend seen in average hourly earnings (4.27% year-on-year in the third quarter to 4.07% year-on-year in the fourth).

On inflation, while headline CPI was stronger than expected, it is worth noting that the Fed’s preferred measure is core personal consumption expenditures (PCE). Given a much weaker than expected PPI print in December (which phases well into core PCE), the six-month annualised rate on core PCE is expected to come in at 1.9%, just below the Fed’s target of 2%. While their job is not done, it sounds like Waller remains confident that things continue to move in the right direction. 

That confidence will not necessarily feed through to seven cuts though, particularly if forecasts continue to follow the Fed’s expected path, where inflation cools at the same time the labour market gently moderates without significantly hurting the economy. While Waller did not explicitly push back on the pricing of a March cut by the market (~80% before his speech), he did give some clues as to what that cutting cycle would look like when they start, in particular saying that there is no reason to “move as quickly or cut as rapidly as in the past”, and that when they start it will be done “methodically and carefully”. 

We would expect the message from Powell at the end of this month to be along a similar vein. While we do not think the Fed will cut in March, it might want to keep the optionality open given the three months of data that has to come before that meeting. What might be more likely, however, is the fact that when they start (be it in March or later), the number of cuts this year is unlikely to be seven unless we get a period of deflation or a more meaningful downturn.