【US Interest Rates】Waller: FOMC Meeting Pivot Supports No Rate Cuts; Concerned About Continued Hormuz Strait Blockade, Sustained High Oil Prices Could Lead to Inflation Exceeding Expectations

Federal Reserve Governor Christopher Waller said in an interview with foreign media that he initially supported a rate cut in March due to a sharp decline of 92,000 non-farm jobs, but with the closure of the Strait of Hormuz, it appears to be a prolonged conflict. Oil prices are expected to stay high for a longer period, indicating that inflation is more concerning than I previously thought.

He continued, saying that many studies show that labor force growth will be zero or close to zero, with zero being the net addition of new jobs.

Regarding oil prices, he stated, “If oil prices are at very high levels and remain high for several months, then at some point, it will seep into the economy because oil is a key input cost for many products. This is very different from tariffs on toys. Tariffs on toys don’t spread to all other goods in the economy. But oil is a major intermediate import, and eventually, it will permeate through. That’s why you worry about sustained high oil shocks. This isn’t just a temporary fluctuation that goes up and then down.”

He believes that in the 1970s, people forgot that it wasn’t a single oil shock but a series of shocks. “If you encounter a series of single shocks, it looks like a permanent change rather than a few temporary events. But later, everyone realized that reacting to all this might have been a mistake—you need to ‘de-emphasize’ these things. Starting in the 1980s, it became a common consensus among central banks: these oil price events, they go up and then down, and you shouldn’t react to them.”

“I always want to emphasize that oil prices rising and then falling is very different from oil prices rising and staying high for a long time. That’s what causes it to seep into core inflation, and at that point, you have to react instead of ignoring it.”

“So, one of the key points I started thinking about is: if this continues, inflation could be more serious than I imagined. Now, we can only wait and see. We don’t know how things will develop. But we must consider that perhaps ‘caution is prudent.’”

“In March 2022, just before we were about to lift the zero lower bound policy in March, I argued that we should raise rates by 50 basis points (0.5%). But afterward, Russia invaded Ukraine. At that time, everyone’s attitude was the same as now: ‘We need to be cautious.’ So, for now, we hold steady. That’s also my current stance.”

“This doesn’t mean I will stay on hold for the rest of the year. I just want to observe how things develop. If the situation progresses relatively smoothly and the labor market remains weak, I will advocate for rate cuts later this year.”

Regarding discussions on rate hikes at the FOMC, Waller said, “I’m not speaking on behalf of my colleagues; I just want to share some theoretical perspectives.”

“If you think… for example, in December 2024, the overall PCE inflation rate is 2.8%. It’s roughly the same now—around 2.8%. So inflation has hardly changed during this period. If you’re worried it will rise from this level, some might say: ‘Look, we need to raise rates to bring inflation down and control it.’ But my view is: if in December 2024, it’s 2.8%, and now it’s 2.8%, this isn’t structural. Because if it were structural, and you believe tariffs have already been passed on—say, 50 to 100 basis points—then inflation should be around 3.5% to 4.0%, not 2.8%.”

Waller pointed out that as inflation approaches 2%, “that’s why I think once we pass the second quarter, the impact of tariffs will fade, and you’ll see inflation decline. Because once the tariff effects are absorbed, only structural factors remain. If you believe it will rebound significantly, that’s another story. But based on the math I just explained, there’s no need to raise rates. Yes, we’re not seeing progress, but that’s because tariffs pushed it up, and structural factors pulled it down, balancing each other out.”

He believes tariffs are a one-time price level effect, not ongoing inflation. So, inflation expectations haven’t become unanchored. Whether in market pricing or household surveys (which are quite volatile), market pricing shows no signs of expectations de-anchoring, even with persistently high inflation. He said the market understands the logic that “tariffs have been passed on,” and that potential structural inflation may have already declined. When tariff effects fade, inflation will decrease.

“If by the second half of the year, tariff impacts haven’t faded and inflation starts rising, then we’re in a dilemma: should we worry about inflation or risk a recession? Back in 2022, when I advocated aggressive rate hikes, I said a recession wouldn’t happen because the labor market was very strong—quite different from the current labor market,” he said. “So I will closely monitor future labor market data to see if I should advocate for rate cuts at upcoming meetings. But I also need to watch inflation.”

Regarding war’s impact on the economy, Waller said, “Historically, when unemployment rises, it tends to spike sharply. I’ve always thought there’s some ‘herding effect.’ If you’re a company on the edge and see everyone else laying off workers, you’ll do the same. This herd behavior causes unemployment to spike non-linearly. It only takes some coordinated shock to push people in that direction. I don’t know if this war, if it lasts for months, will be the trigger. When will consumers start to pull back? I mean, they look at their gas tanks, watch oil prices, compare their spending on cars versus other things, and this begins to influence their overall economic outlook. All these factors could eventually lead—I’m not saying a recession—but the economy could weaken much more suddenly than expected.”