Fed May Cut Interest Rates Sooner If Inflation Continues to Cool

Federal Reserve Governor Christopher Waller indicated that the central bank could reduce interest rates more quickly than previously anticipated if inflation trends continue to soften. Waller's comments highlight a potentially more aggressive approach to rate reductions, as many analysts had suggested a slower path.

During an interview on CNBC, Waller noted, "Inflation is getting close to what our 2% inflation target would be." He referenced estimates showing that a critical measure of core inflation, the Personal Consumption Expenditures (PCE) Price Index excluding food and energy, has approached the Fed's target level for six of the past eight months.

The upcoming monthly PCE report is expected on January 31, just after the conclusion of the Fed’s next policy meeting. Analysts predict that this report will reveal a monthly increase that could result in an annual core inflation rate of below 2%.

Waller expressed optimism about the disinflationary trend, stating, "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." He mentioned the possibility of three or four quarter-percentage-point rate cuts this year, contingent upon how inflation performs.

The governor also suggested that if inflation decreases while the job market remains stable, the Fed might consider initiating rate cuts in the coming months, including the possibility of acting as early as March during the March 18-19 policy meeting. Waller said, "If we make a lot of progress, you could do more."

Waller's remarks seem to have shifted market expectations regarding the Federal Reserve's stance in light of a new administration taking office. Investors had expected that the Fed would maintain its benchmark rate in the current range of 4.25%-4.50% until later in the year, with only one anticipated rate cut.

However, following Waller’s comments, investors began to favor the idea of two rate decreases this year, with the first likely occurring as early as May. Bond yields dropped as a result, reflecting this shift in sentiment.

Despite strong retail sales and low unemployment suggesting a robust economy, Waller indicated that the economy remains under control. Some analysts argue that the Fed's policies may not be restrictive enough to curb potential inflation spikes. Waller countered this by stating, "you are not seeing a labor market that is starting to overheat or accelerate. Things are still restrictive."

Looking ahead, the Fed is also considering how the newly elected President's policies may impact the economy and inflation. Waller downplayed the potential lasting effects of increased tariffs on imports, stating, "I don’t think tariffs would have a significant impact or persistent effect on inflation."

Fed, Inflation, Rates