Next week's CPI will be the key to victory! Federal Reserve's Waller: Inflation has shown signs of easing, but if data rebounds, will "support rate hikes"

Federal Reserve Governor Waller warned that the August inflation data to be released next week will largely determine his voting stance at the upcoming policy meeting—if the data is hot, he will consider supporting a rate hike.

Speaking at a Reuters-hosted event on Thursday, Waller stated, "If the inflation data comes in hot, I would consider supporting a rate hike," adding that even a "slight acceleration" in inflation could prompt him to shift toward a more hawkish policy stance. He also mentioned that recent data shows inflation is "finally showing some signs of cooling," but it remains clearly above the Fed's 2% target.

These remarks pushed Treasury futures higher, led to a steepening of the yield curve, and caused the dollar index to drop to its lowest level of the day. The implied probability of a rate hike in September, reflected in federal funds rate futures, was above 60% at the time, but after Waller’s comments, market pricing for tightening in September fell slightly from 16 basis points to about 13 basis points, and cumulative rate hike expectations by year-end narrowed from 38 basis points to about 34 basis points.

Waller explicitly identified next Friday’s (September 11) release of the August Consumer Price Index (CPI) as a key decision-making factor. He noted that if the data show continued progress toward the 2% target, he would be inclined to hold steady; but if there is a setback, "a slight adjustment in policy stance would help ensure that inflation returns to a downward trajectory."

Currently, the Federal Reserve has kept rates unchanged at five consecutive meetings, and officials will meet in Washington again from September 15 to 16 for the policy meeting. Waller believes that the current policy rate imposes only a "mild" constraint on the economy, which means that even a moderate inflation rebound could break his willingness to hold rates steady.

Before Waller’s remarks, there were clear divisions within the Fed. At the July meeting, three voting members of the Federal Open Market Committee (FOMC) supported a 25-basis-point hike, highlighting the presence of hawkish forces inside the central bank.

Fed Chair Walsh stated at the Jackson Hole annual economic symposium last week that it is still unclear whether overall financial conditions are genuinely restrictive, and if officials are not confident about the inflation path, "there is still work to be done." Governor Michael Barr also warned on Tuesday that after inflation has consistently exceeded targets for over five years, there is an entrenched risk of price pressures, and the central bank should be prepared for a rate hike this month.

In contrast, New York Fed President John Williams took a milder stance, saying that there is evidence of inflation continuing to cool as tariff shocks fade, and the rise in energy prices has yet to spill over into other services sectors.

Waller also articulated his position on central bank communication during his remarks, creating a sharp contrast with Walsh’s approach. He said that effective monetary policy communication should focus on three objectives: the current policy stance, the outlook for policy, and forward guidance under specific circumstances.

Walsh has previously pledged to reform the central bank’s external communication methods, including removing forward guidance and reducing the number of speeches and official statements. This strategy was criticized by bond investors in July for not providing enough economic outlook information.

Waller was cautious about this. He agreed that forward guidance is not always applicable, "but when it is truly needed, I think it should be used." He emphasized that clearly conveying policy direction to businesses and households helps provide the public with more explicit expectations.

Markets reacted swiftly after Waller’s remarks. Treasury futures climbed to session highs; yields on the two- to ten-year maturities dropped 2 to 3 basis points across the board, with the front and middle of the yield curve performing the strongest. The two-year/ten-year and five-year/thirty-year spreads both widened by more than 1 basis point, hitting new daily highs. The dollar index (BBDXY) fell about 0.5%, while the yen surged, with intraday gains reaching as much as 2%.

Markets are currently highly focused on two upcoming data releases: Friday's jobs report and the September 11th CPI. Waller said he expects the employment data to confirm that the labor market is in a "satisfactory state." There remains considerable uncertainty regarding the policy direction for September until the inflation data is released.