Fed May Cut Rates Sooner If Inflation Continues to Cool

Federal Reserve Governor Christopher Waller stated that inflation is likely to ease, potentially allowing the central bank to cut interest rates sooner and more aggressively than previously anticipated. Waller's comments highlight a possible change in market expectations regarding the Fed's approach to rate adjustments.

Waller mentioned on CNBC that inflation is approaching the Fed's 2% target. He pointed out that one significant measure of inflation, the Personal Consumption Expenditures Price Index excluding food and energy, has been hovering close to this target for about six of the last eight months.

The next monthly PCE report is expected on January 31, just after the Fed's upcoming policy meeting. Analysts are hopeful that the monthly rise in core inflation may reflect an annual rate below 2%.

He stated, "If we continue getting numbers like this, it is reasonable to think rate cuts could happen in the first half of the year. I am optimistic that this disinflationary trend will continue and we will get back closer to 2% a little quicker than maybe others are thinking." Waller suggested that as many as three or four quarter-percentage-point rate reductions could still be feasible this year, depending on inflation trends.

Waller further speculated that if inflation decreases and the labor market remains healthy, the Fed might start considering rate cuts in a few months, hinting that the March policy meeting could be in play for such decisions.

His moderate stance, expressed just before the Fed's blackout period ahead of the January 28-29 meeting, shifted market sentiment about the central bank’s planned rate moves. Analysts had expected the Fed to maintain its benchmark overnight rate in the range of 4.25%-4.50% in the upcoming meeting, with a potential pause lasting until around June, along with only one rate cut this year.

However, following Waller’s remarks, investors began leaning towards the likelihood of two rate cuts, with the first potentially occurring as early as May. Reactions in the bond market included a reduction in yields.

Some analysts have pointed to strong retail sales and a relatively low unemployment rate as indicators that the Fed's policy might be less restrictive than previously imagined, leaving the door open for a renewed wave of inflation. Nevertheless, Waller noted that the labor market does not currently show signs of overheating, suggesting that conditions remain restrictive overall.

There is also consideration regarding President-elect Donald Trump's policies and their potential impacts on the economy. Waller suggested that any inflationary effects from elevated tariffs on imports would likely be temporary, stating, "I don’t think tariffs would have a significant impact or persistent effect on inflation."

inflation, rates, economy