Federal Reserve Governor Christopher Waller has given gold prices a boost on Tuesday after a speech in which he listed several indications that inflation was indeed continuing to retreat back toward the central bank’s 2% target.
Speaking at the American Enterprise Institute, Waller began by referring back to his speech in October, entitled ‘Something's Got to Give,’ in which he observed “strong economic growth and employment data” in Q3, alongside “clear moderation in core personal consumption expenditures (PCE) inflation.”
“While this was good news for employment growth, the pace of real economic activity seemed inconsistent with continued progress toward the Federal Open Market Committee's (FOMC) goal of 2 percent inflation,” he said. “It seemed clear to me then that something had to give— for inflation to continue falling to our 2 percent target, the economy needed to slow from its torrid third-quarter pace. If it did not cool off, then it was likely that progress on inflation would stop or even reverse. So, what remained to be seen was whether the economy would cool or inflation would heat up.”
Waller said he is encouraged by the data from the past few weeks, as he sees slowing in the economy. “Data for October indicated an easing in economic activity, and forecasts for the fourth quarter show the kind of moderation that is more in keeping with progress on lowering inflation,” he said. “In addition, after watching core PCE inflation increase in September from its summer lows, the latest data showed inflation moving in the right direction in October, albeit gradually.”
While the Fed governor said it’s still too early to say whether the slowing will be sustained, he said he is “increasingly confident that policy is currently well positioned to slow the economy and get inflation back to 2 percent.”
Looking at overall economic activity, Waller said that the initial estimate of Q3 real gross domestic product (GDP) was “a vigorous 4.9 percent […] We'll find out tomorrow if that estimate holds up, but growth in the quarter clearly picked up from the first half of 2023, when real GDP grew at a little more than a 2 percent pace,” he said. “Growth in consumer spending, which accounts for most of GDP, was strong in the third quarter.”
However, he said that October data indicates that consumer spending is cooling from its torrid Q3 pace. “Retail sales fell 0.1 percent, the first drop since March,” Waller noted. “[E]ven without motor vehicles and sales at gas stations, retail sales barely increased in October, which may reflect a broad-based moderation in demand.”
He also observed that business activity appears to have slowed in October. “[M]anufacturing output edged up only 0.1 percent last month,” he said. “Surveys of purchasing managers by the Institute for Supply Management indicated that both manufacturing and non-manufacturing activity slowed in October.”
Waller said the latest forecasts from GDP models are predicting “a significant moderation in economic activity” in the fourth quarter of 2023. “After the retail sales report for October, the Atlanta Fed's GDPNow model is forecasting a 2.1 percent pace of increase for these three months, nearly identical with the actual growth rate for the first half of the year,” he said. “Private inventory investment contributed 1.3 percentage points to GDP in the third quarter and that likely won't be sustained. Inventory swings could even subtract from GDP in future quarters.”
“All in all, it seems like output growth is moderating as I had hoped it would, supporting continued progress on inflation.”
Waller noted that the labor market is also cooling off. “Job creation is down this year from the high rates of 2022, and the unemployment rate has risen from a more than 50-year low of 3.4 percent in April to 3.9 percent in October,” he said. “The ratio of job vacancies to people seeking work has fallen, and so has the rate of people voluntarily quitting their jobs. Average hourly earnings, which grew at an annual rate of more than 5 percent last year, have decelerated more or less steadily in 2023 to 4.1 percent in October.”
He then turned to the progress he’s seeing on the inflation front. “Consumer price index (CPI) inflation for October was what I want to see,” he said. “For the month, there was no inflation, prices were virtually flat, and unlike earlier moments where improvements were concentrated in some goods and services, the moderation in inflation was broadly distributed.”
Waller emphasized that the FOMC uses personal consumption expenditures (PCE) as its preferred measure of inflation, which runs lower than CPI inflation. “We'll get October PCE inflation on November 30,” he said, “but a rough estimate based on differences with CPI and the producer price index indicates that headline PCE inflation was 3 percent over three months and 2.5 percent over six months.”
“The question is whether inflation can continue to make progress toward 2 percent,” Waller said, before listing a number of factors that suggest this is indeed happening.
“First, housing services inflation, based heavily on rents, has slowed from its peak last year, and the lagged effect of moderation in rental prices in the past year should keep this sizable component of inflation at a moderate level,” he said. “Goods prices have contributed a lot to the decline in inflation recently and have moderated so much that they probably won't be contributing much more. But services excluding housing, which accounts for about half of PCE inflation, has not moderated as much as other categories, and there will have to be some improvement there for overall inflation to reach 2 percent.”
Waller said the recent moderation in wage growth, as seen in the Atlanta Fed's Wage Growth Tracker, which was as high as 6.4 percent in March but fell to 5.2 percent in October, “is encouraging, but it is not enough evidence to be sure it will continue.”
“Just a couple of months ago, inflation and economic activity bounced back up, and the future was looking less certain,” Waller said. “And while it is encouraging to see inflation by the FOMC's preferred measure dipping below a 3 percent rate over the last three or six months, our target is 2 percent, and policy needs to be set at a level that moves inflation to 2 percent in the medium term.”
Waller said he will be “closely monitoring the pressure on various categories of goods and services prices in the coming weeks” to determine if inflation is continuing to drop.
“Let me turn now to the implications of all this for monetary policy,” he said. “I would start with the point I made at the outset—monetary policy is restrictive, and it is clearly contributing to the rapid improvement in inflation in the last year. The FOMC raised the federal funds rate from near zero to more than 5 percent, the sharpest increase in more than 40 years, and, as some people have noted, we have seen the most rapid decline in inflation on record.”
Waller said high inflation was partially due to supply-side problems related to the pandemic, “[b]ut most data indicators and anecdotal evidence suggests that supply side problems are largely behind us so they will provide little support in the future in returning inflation to our 2 percent goal.” He said that monetary policy “will have to do the work from here on out” to return inflation to its target.
“The October data I have cited on economic activity and inflation are consistent with the kind of moderating demand and easing price pressure that will help move inflation back to 2 percent, and I will be looking to see that confirmed in upcoming data releases,” Waller said. “Before the next FOMC meeting we will get data on PCE inflation and job openings, and a job report and supply manager's survey for November. CPI inflation will come out on December 12, the first day of the FOMC meeting.”
“All of that data will tell us whether inflation and aggregate demand are continuing to move in the right direction and inflation is on a path to our 2 percent goal,” he concluded.
According to the CME FedWatch Tool, markets are pricing in a 96.3% chance of a hold at the Dec. 13 FOMC meeting. The expectations for lower interest rates are rising steadily thereafter, with a 34.6% chance of a 25-basis-point cut at the March 20 meeting, which rises to a 48.3% chance at the May 1 meeting. For June, markets see a 39.1% chance that the Fed funds rate is 25 bps lower than it is today, and a 36.2% chance that it’s 50 bps lower.
Spot gold was up 1.36% on the session at the time of writing, last trading at $2041.60
BDST: 1925 HRS, NOV 29, 2023