Federal Reserve Governor Waller notes that while headline labour market numbers appear acceptable, it would not require much to destabilise them. Business executives report they are neither hiring nor firing, suggesting stability yet underlying concern.
Monetary policy discussions involve robust debate, centred on economic arguments rather than politics. Waller emphasises careful consideration before opposing interest rate decisions, implying timing of rate cuts is flexible, though there is no compelling reason to delay.
Impact Of Tariffs On Inflation
Tariffs function as a tax, distributing costs across different groups. Short-term inflation impacts of tariffs should be assessed over three to six months. Although some costs will trickle down to consumers, they are unlikely to trigger ongoing inflation unless tariffs persist.
Waller aims to avoid a hard economic landing, noting that long-term inflation expectations remain stable. He stresses the importance of maintaining credibility to prevent inflation expectation spikes.
Recent commentary from Waller, known for his dovish stance, suggests potential rate cuts or focus on downside risks, though his views are less impactful than earlier. Waller may be the sole dissenter on rate decisions at the July meeting, alongside Bowman, due to their more dovish positions.
Market Reaction And Economic Slowdown
Based on the Governor’s comments, we believe the market is underpricing the risk of a near-term economic slowdown. His concern that the labor market could “tip” easily suggests we should add downside protection. We are considering buying put options on major indices expiring after the next couple of jobs reports.
The focus on the fragility of the private sector, despite headline numbers, is a clear signal. Recent JOLTS data showing job openings fell to 8.059 million, the lowest level since early 2021, validates his cautious stance. This reinforces our view that derivative positions should be skewed towards a potential softening in the economy.
His remarks about rate cuts indicate a high degree of data dependency, creating uncertainty around the July meeting. With the market currently pricing a roughly 85% chance of a rate cut by September via the CME FedWatch Tool, any surprisingly weak data could pull those expectations forward dramatically. This makes short-term options, or straddles, on interest rate futures an attractive way to trade the increased volatility.
The internal disagreement at the central bank, particularly between a pragmatic member like him and a consistent hawk like Bowman, adds another layer of unpredictability. This healthy debate means policy is less certain, and we should not be overly committed to a single outcome. Our strategy is to remain nimble, using derivatives to express views rather than holding large directional spot positions.
His perspective on tariffs as a one-off tax, rather than a driver of persistent inflation, is important for our inflation expectations. With the latest annual core PCE inflation reading already down to 2.6%, the central bank has more room to react to growth scares than the market perceives. We are therefore cautious about betting on higher inflation and are instead positioned for yields to fall if growth data weakens.
