Federal Reserve Gov. Christopher J. Waller voiced concerns Monday over recent inflation data, signaling that the central bank must proceed cautiously on interest rate cuts.

Speaking at a conference at Stanford University, Waller struck a slightly hawkish tone, highlighting the U.S. economy's strength while acknowledging worries over recent inflation upticks.

Solid Economic Growth but Disappointing Inflation

Waller emphasized the economy is on “solid footing,” with employment near the Federal Open Market Committee’s (FOMC) maximum objective. But he added, “The latest inflation data was disappointing.”

Despite progress in reducing inflation, recent figures suggest uneven progress toward the Fed’s 2% target.

Waller praised the economy’s resilience, noting that real GDP grew at a 2.2% annual rate in the first half of 2024 and is expected to accelerate in the third quarter.

He also mentioned that household resources remain in good shape, though lower-income groups continue to face financial strain. “These revisions suggest that the economy is much stronger than previously thought, with little indication of a major slowdown in economic activity,” Waller said.

‘Considerable Pent-Up Demand’ As Interest Rates Fall

Waller highlighted continued strength in consumer spending, despite some moderation.

Growth in personal consumption expenditures (PCE) has averaged around 2.5% this year. Waller’s business contacts expressed optimism about “considerable pent-up demand” for durable goods and home improvements, demand that has been delayed due to high interest rates.

As interest rates for credit cards and home equity loans begin to decline, Waller expects consumers to resume purchasing “durable goods, home improvements, and other big-ticket items.”

“Now that rates have started to come down and are expected to come down more, consumers will be eager to make those purchases,” he said.

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Jobs Market Remains Quite Healthy

Waller also addressed the September jobs report, which far exceeded expectations. “The labor market remains quite healthy,” he said, pushing back against speculation that the Fed might have considered an emergency rate cut earlier in the summer.

While Waller expects payroll gains to slow, he believes job growth will continue at a “solid rate.”

He did, however, caution that interpreting the October jobs report may be difficult due to temporary disruptions from recent hurricanes and the Boeing strike, which are expected to skew the numbers.

Inflation Rollercoaster and Rate Outlook

Turning to inflation, Waller expressed concern over September's likely increase in PCE inflation, the Fed's preferred measure. “We have made a lot of progress on inflation over the last year and a half, but that progress has clearly been uneven — at times it feels like being on a rollercoaster,” Waller said.

He remains uncertain whether the recent uptick in inflation is a temporary blip or a signal of more persistent inflationary pressures. “I will be watching the data carefully to see how persistent this recent uptick is,” he added.

Despite these concerns, Waller reaffirmed his outlook for gradual rate reductions over the next year, aligning with the FOMC’s median projection of 3.4% for the federal funds rate by the end of 2025.

However, he acknowledged, “There is less certainty about the final destination.”

Market Reactions

Waller’s remarks have not significantly shifted interest-rate expectations. According to the CME FedWatch Tool, the odds of a 25-basis-point rate cut remained steady at 86%.

However, if more Fed policymakers also express concerns about inflation in the days to come, and if Thursday's retail sales data exceeds expectations, the likelihood of the Fed holding rates unchanged could rise from here.

On Monday, Treasury yields were largely stable, with the two-year note yield — sensitive to rate policy — hovering around 4%. The U.S. dollar index (DXY), tracked by the Invesco DB USD Index Bullish Fund ETF (NYSE:UUP), rose 0.3%, reaching its highest level since late July.

Meanwhile, the S&P 500 index, monitored via the SPDR S&P 500 ETF Trust (NYSE:SPY), gained 0.8% to close at 5,859 points, extending its record highs.

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