On Monday, Federal Reserve Governor Christopher Waller delivered a keynote speech in New York. He acknowledged that significant inflation risks persist, while also cautioning markets against mechanically applying the old playbook from 2021 to combat inflation, thereby avoiding overly aggressive preemptive rate hikes. He outlined the multiple drivers of the current inflationary episode, distinguished between two distinct economic outlooks, and argued for a policy approach that maintains a careful balance—neither falling behind the curve on inflation nor tightening policy in haste.
The speech came just one day before the release of June U.S. CPI data, providing clear observational clues for the future path of Fed interest rates in the context of market expectations for a rate hike at the late-July policy meeting.
Diversified Inflation Drivers, AI Adds New Long-Term Price Pressure
In his remarks, Waller stated that past market interpretations of inflation often focused on two traditional factors: tariffs and energy price increases. However, the underlying logic for prices persistently exceeding the 2% target has now changed. The robust demand generated by the artificial intelligence industry has become a new and significant inflationary force. He identified three core sources of price pressures: import tariffs set to take effect in 2025, elevated international energy costs due to Middle East conflicts, and the demand spillover effects from the expansion of the AI supply chain. The combination of these multiple factors is making inflation stickier than previously anticipated by the market.
Waller noted that policymakers can easily fall into a cognitive trap, where deliberately avoiding past mistakes can create new problems. He admitted that the Fed was slow to act against inflation in 2021, a historical lesson that constantly reminds him, but this does not mean that immediate rate hikes are needed now to suppress prices. Policy formulation must objectively distinguish the underlying environments of the two inflationary episodes and avoid simply replicating past actions.
Two Economic Scenarios in Play, Policy Actions Require Balanced Calibration
Waller predicted that the market faces two equally plausible development paths. In the first scenario, various inflationary factors gradually subside, inflation steadily declines, and the Fed can maintain the current level of interest rates. In the second scenario, inflation remains persistently high or even rebounds, making a near-term tightening of monetary policy a necessary choice.
He placed strong emphasis on balanced thinking: policymakers must not rush to initiate rate hikes simply because of past policy lags; at the same time, they must avoid the mistakes of 2021-2022 by not persistently watching from the sidelines and allowing inflation to run hot. Two current buffer conditions provide the Fed with room to observe: a robust labor market has not yet spawned wage-driven inflation, and various market indicators show that inflation expectations remain broadly anchored, unlikely to spiral out of control quickly.
However, Waller explicitly countered a common misconception: the belief that as long as inflation expectations are stable, the central bank need not intervene when inflation exceeds the target. He stated that simply waiting for prices to fall on their own is not a practical strategy, and policymakers must not develop a complacent mindset.
Focus on June CPI Data, Sustained Cooling Required to Pause Hikes
At 20:30 Beijing time on July 14, the U.S. Bureau of Labor Statistics will release the June CPI data.
Institutional surveys indicate that a significant decline in international crude oil prices could pull the overall inflation rate down by 0.2% month-on-month, while core CPI (excluding food and energy) is expected to rise slightly by 0.2% month-on-month. On a year-on-year basis, overall inflation is projected to fall from 4.2% to 3.8%, with core inflation dipping slightly to 2.8%.
Regarding this, Waller stated that a decline in core inflation for a single month is insufficient to confirm a trend. Core inflation has been heating up in the first half of the year, and multiple consecutive months of cooling data are necessary to determine that inflation is back on a downward path. If subsequent data shows continued improvement, the Fed will keep interest rates unchanged at their current level.
Data from CME Group shows that market pricing assigns only a 39% probability of a rate hike at the late-July policy meeting, reflecting a broad investor consensus on a near-term wait-and-see policy stance.
Conclusion
Overall, Waller's speech conveyed a cautiously neutral policy stance. The current inflationary episode, compounded by multiple variables including AI, geopolitics, and tariffs, cannot be addressed by simply copying previous tightening experiences. The Fed is unlikely to raise rates easily in the near term. The core criterion for observation will be multiple consecutive months of cooling inflation data, while maintaining vigilance against a potential inflation rebound.
The U.S. June CPI data and the late-July policy meeting will be key milestones for judging the direction of interest rates. The labor market, AI industry demand, and the Middle East energy situation will continue to influence the pace of the Fed's subsequent policy adjustments.
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