Waller makes his case. Market ignores. Like talking to a wall
July 18, 2025
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-Waller specifically calls for a rate cut at the July meeting. The market is fine with pegging him as a dissenter where the majority, led by Powell, will vote for no change. FFQ5 prints unch’d at 9568 this morning; little odds for a cut. SFRU5 is 9582.5, up 1.5. That’s just 15.5 bps above the current EFFR of 4.33% or 9567.0. Next FOMC meetings July 30 and Sept 17.
From Waller’s speech:
So let me follow my own advice and state up front the reasons I believe we should cut the policy rate at our meeting in two weeks.
First, tariffs are one-off increases in the price level and do not cause inflation beyond a temporary surge. Standard central banking practice is to “look through” such price-level effects as long as inflation expectations are anchored, which they are.
Second, a host of data argues that monetary policy should be close to neutral, not restrictive. Real gross domestic product (GDP) growth was likely around 1 percent in the first half of this year and is expected to remain soft for the rest of 2025, much lower than the median of FOMC participants’ estimates of longer-run GDP growth. Meanwhile, the unemployment rate is 4.1 percent, near the Committee’s longer-run estimate, and headline inflation is close to our target at just slightly above 2 percent if we put aside tariff effects that I believe will be temporary. Taken together, the data imply the policy rate should be around neutral, which the median of FOMC participants estimates is 3 percent, and not where we are—1.25 to 1.50 percentage points above 3 percent.
My final reason to favor a cut now is that while the labor market looks fine on the surface, once we account for expected data revisions, private-sector payroll growth is near stall speed, and other data suggest that the downside risks to the labor market have increased.
–There are a lot of obvious signs that financial conditions are already easy. Stocks at new highs (and levitating upwards on little volume), USD is soft. Corporate spreads are tight. The only factor that could be spilling into the restrictive bucket is long rates, with the 30y hovering around 5%. In terms of labor, some would consider a rate at 4.1 to 4.2 as full employment.
–Yesterday’s session was quiet with a flatter bias. 2y yield up 3.4 bps to 3.915%. Tens up 1.4 to 4.465%. Once again, the ten-year breakeven (treasury – tip) edged to a new high 246.5. The high of this calendar year was in Q1 at 247.5. 2024 high was 243.0, 2023 high was 251.6. In 2022, the October high was 257.7, but in April it was 303.6. The Fed (& Waller) might correctly say from this data that inflation expectations are ‘anchored’ but not at 2%, rather at 2.5%. And if neutral is 1.25% that points to a funds rate of 3.75-4.00 vs today’s 4.25-4.5%. Forward SOFR contracts (reds) seem to be comfortable around 3.25%, testing 3% every now and then.
–Today’s news touches upon inflation expectations. U of Mich 1-yr expected 5.0% from 5.0% last month. 5-10 year expectations 3.9% from 4.0%. NOT anchored. Housing Starts as well this morning.
–When the Fed started to cut, it was in September, just after the yen-carry turmoil of early Aug when yen surged ($/yen collapsed from 154 to 142 in a few days). Low in $/yen just below 140 coincided with the Fed’s 50 bp ease. Japanese election on Sunday. Yen has been trending weaker this month, with $/yen up to 148.70.
