Fedwatching: Gov. Waller on the outlook (May 30 2022)

Synopsis of Governor Waller's speech on May 30...

- Sees overall economy as strong

- Q1 contraction was due to inventories and net exports, and he doesn't expect that contraction to be repeated. Spending and business investment are still strong

- Labor market remains strong. Creating about 500,000 jobs per month, with unemployment at a 50-year low

- Inflation is "alarmingly high." April CPI at 8.3, which will go up due to gasoline prices, and core CPI at 6.2 plus headline PCE at 6.3 is still way above target

- Causes - consumer demand + supply bottlenecks - don't matter that much as the bottom line is that the price stability mandate is not being met. Waller's priority is to get inflation down so we don't have a ramp up in future inflation expectations. Can't afford for inflation expectations to become unanchored

- Long-run inflation expectations have inched up to above 2 percent

- FOMC is united in bringing down inflation and hitting the 2 percent target. 75 bps of hikes already this year, with forward guidance for more hikes

- Waller wants 50 bp hikes for "several" meetings, and to not take hikes off the table until he sees inflation coming closer to the 2 percent target. Also wants the policy rate above neutral

- Fed funds futures are pricing in a year-end policy rate of about 2.65%. Comes out to 175 bps of hikes left for the year. "If we need to do more, we will"

- Financial conditions already tightened. Mortgages up 200bps, 10y UST up to 2.8%

- Balance sheet rolloff begins June 1. Expect $95 billion to roll off per month by Sep. This amounts to $1 trillion of reduction in the balance sheet, which models suggest are ~2 25bp rate hikes

- Global shift to tightening. Euro area saw headline inflation of 7.5% in April, EMs are hiking from 3.5% on average to about 5% by year-end (based on market pricing). DMs are also either tapering or rolling off the balance sheet

- Waller pivots to discussing tightening and labor markets. Thinks tightening will lead to a reduction in labor market demand (# of vacancies) but may not lead to much unemployment. Right now vacancies are very high, with a tight labor market, so many are not going to get filled anyway--if those vacancies go away due to tightening, there's not much loss.

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