What Does Waller Think? Will There Be a Rate Hike in September? Markets Are in a Dilemma Ahead of the August Jackson Hole Meeting

Author: Li Jia, The Wall Street Journal

Federal Reserve Chairman Waller's first press conference sent a policy signal of "clear objectives, but unclear paths." As the August Jackson Hole meeting approaches, the market will closely watch how Waller defines the Fed's reaction function and whether there is a risk of an unexpected rate hike in September.

Morgan Stanley's latest report suggests that Waller is deliberately changing the way the Fed communicates with the market. He has clearly conveyed three signals: current inflation remains high, the policy goal is to bring inflation back to target levels, and he maintains confidence in achieving this goal. However, he consistently avoids the most pressing question for the market—what specific path the Fed will take to achieve this goal.

This means that the core of the market's game in the coming weeks will revolve around one question: if financial conditions continue to tighten but are still insufficient to suppress inflation, will Waller choose to proactively strengthen policy tightening? The Jackson Hole meeting may become an important window to observe this policy shift.

Waller's Communication Logic: Clear Objectives, No Path Provided

Morgan Stanley's research on Waller's previous statements at FOMC meetings reveals that he is intentionally widening the gap between the Fed and market expectations.

Waller emphasizes only three dimensions: past inflation assessments—current inflation is still at a high level; future policy goals—driving inflation back to target; and confidence in achieving these goals—maintaining a high degree of certainty about this.

However, the problem is that this communication framework does not inform the market about how the Fed will act.

In the past, the Fed typically helped the market form policy expectations through forward guidance, while Waller prefers to let the market judge economic trends on its own and assess the possible policy paths the Fed might take. He is not concerned about discrepancies between market views and the Fed's perspective, nor will he adjust policy positions to align with market expectations.

Tightening Financial Conditions Do Not Mean the Fed Will Remain Passive

The decision to pause rate hikes at the July FOMC meeting was partly due to the fact that financial conditions had already tightened in advance. Factors such as rising market interest rates and asset price adjustments have partially taken on the role of tightening monetary policy, which Waller seems to acknowledge.

However, Morgan Stanley believes that the market cannot simply infer that as long as financial conditions tighten, the Fed will reduce its actions.

Waller does not believe that market tightening can fully replace central bank policy. He is focused on whether the tightening of financial conditions truly achieves the effect of suppressing inflation, rather than merely observing changes in market indicators.

If future data shows that tightening financial conditions have not effectively reduced inflationary pressures, Waller may choose to take proactive measures again. This is also a key reason for his avoidance of providing a clear policy path—he wants to retain sufficient policy flexibility.

Risks Hidden in September Rate Hike Expectations, Markets Await Signals from Jackson Hole

Currently, the market has largely priced in a 25 basis point rate hike at the September meeting, but Morgan Stanley warns that inflation data in the next two months could disrupt this expectation.

If inflation data for July and August continues to exceed expectations, the market may bet again on the Fed taking a more aggressive tightening path. Investors may believe that the previous tightening of financial conditions was insufficient to suppress demand, and the Fed needs to further pressure the economy through actual rate hikes.

In this scenario, Waller's policy choices at the September meeting may show a significant shift compared to July. He may determine that the market environment has not yet reached a sufficiently tight level, thus taking more aggressive policy actions than currently priced in by the market.

Morgan Stanley believes that this constitutes one of the biggest tail risks in the current interest rate market. As the August Jackson Hole meeting approaches, investors will continue to look for clues about the policy reaction function from Waller's speeches and reassess the likelihood of a rate hike in September.