【US Interest Rates】Waller: FOMC Meeting Shifted to Supporting No Rate Cuts, Concerned About Continued Strait of Hormuz Blockade and Sustained High Oil Prices, Inflation Problem More Severe Than Expected

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 will remain 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. Zero means the net addition of jobs is balanced.

Oil is a key input cost for many products

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

Lessons from the 1970s oil shocks should not be overreacted to

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 in the 70s might have been a mistake—you need to ‘dampen’ these effects. Starting in the 1980s, it became a common consensus among central banks: these oil price events, they go up and then come down, and you shouldn’t overreact.”

If oil prices stay high long-term, they will permeate into core inflation

“I always want to emphasize that oil prices going up and then down 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 respond instead of ignoring it.”

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

“In March 2022, before we were prepared to lift the zero lower bound policy in March, I argued that we should raise interest 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 now, we hold steady. That’s also my current stance.”

Monitoring developments; rate cuts possible if labor market remains weak

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

Regarding discussions of rate hikes at the Federal Open Market Committee, Waller said, “I’m not speaking on behalf of my colleagues; I’m just offering some theoretical perspectives.”

“For example, if you think… say, in December 2024, the overall PCE inflation rate is 2.8%. It’s roughly 2.8% now as well. So inflation has hardly changed during this period. If you’re worried it will rise from this level, someone 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%, that’s not structural. Because if it were structural, and you believe tariffs have already been passed through—say, 50 to 100 basis points—then inflation should be around 3.5% to 4.0%, not 2.8%.”

Waller pointed out that inflation is getting closer to 2%, “which is why I think once the second quarter passes, the impact of tariffs will fade, and inflation will come down. That’s because once the tariff effects are digested, only structural changes 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 haven’t seen progress, but that’s because tariffs pushed it up, and structural factors pulled it down, balancing each other out.”

He views tariffs as a one-time price level effect, not ongoing inflation. So, there’s no sign of inflation expectations spiraling out of control. Whether in market pricing or household surveys (which are quite volatile), market pricing does not show signs of expectations de-anchoring, even with persistently high inflation. He said markets understand the logic that “tariffs have been passed through,” and that potential structural inflation may have already declined. When tariff effects fade, inflation will decrease.

If tariffs remain and inflation rises, it will create a dilemma

“If by the second half of the year, tariffs haven’t faded and inflation starts rising, then we face a dilemma: should we worry about inflation or risk a recession? Back in 2022, when I advocated for aggressive rate hikes, I said a recession wouldn’t happen because the labor market was very strong—completely different from the current labor market,” he said. “So I will closely watch upcoming labor market data to see if I should advocate for rate cuts at future meetings. But I also need to monitor 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 kind of ‘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, and compare what they spend on cars versus other things. This begins to influence consumer expectations about the overall economy. All these factors could eventually lead—I’m not saying a recession—but the economy could suddenly be much weaker than we expect.”