Key Takeaways
Fed Governor Christopher Waller has shifted his policy stance sharply, warning that high inflation now poses the primary risk to the U.S. economy and that interest-rate increases may be necessary to bring price pressures under control.
Federal Reserve Governor Christopher Waller said Monday that the balance of risks has "completely flipped" from a year ago, when he was willing to tolerate slower progress on inflation in exchange for labor-market support. With the job market stabilizing and inflation accelerating, the case for tighter policy has strengthened.
"A year ago I was advocating for rate cuts because the labor market was not looking good, so I was willing to tolerate a longer movement back to our 2 percent target based on the labor market," Waller said at an economics conference in Rome. "Those risks have completely flipped around now. The labor market seems to be stabilizing in the US. Inflation has been taking off. So that changes how you might want to think about policy."
The remarks put added focus on the consumer price index report scheduled for July 14, the final major data release before the Fed's July 28-29 policy meeting. The Fed's preferred inflation gauge, the core personal consumption expenditures price index, stood at 3.4 percent in May — well above the central bank's 2 percent target and up from 2.8 percent a year earlier. Headline PCE inflation rose to 4.1 percent from 2.5 percent over the same period.
The fed funds rate currently sits at 3.50 percent to 3.75 percent after six consecutive cuts between September 2024 and December 2025. The median Fed projection from the June meeting now puts the rate at 3.8 percent by year-end, up from 3.4 percent in March — effectively signaling a possible 25-basis-point increase. Nine of 19 Fed officials projected the need for tighter policy this year, according to the dot plot.
Investors currently see about a 25 percent probability of a rate hike at the July meeting, with a move by September more fully priced, based on OIS market pricing. The last time the Fed raised rates was July 2023, when it lifted the fed funds rate to a peak of 5.25 percent to 5.50 percent before beginning an easing cycle in September 2024.
Inflation pressures are broadening beyond energy
The Fed's July Monetary Policy Report, released ahead of Chairman Kevin Warsh's two days of congressional testimony, acknowledged that price increases "began trending up last year and then stepped up further this spring." The report attributed the acceleration to a combination of tariffs, the energy shock following the outbreak of conflict in the Middle East, and surging demand for high-tech equipment tied to artificial intelligence.
Energy prices rose 24 percent from a year earlier, but the inflation is not solely an oil story. Core goods inflation accelerated to 2.4 percent from 0.6 percent, while prices for computers, software and electronics were pushed higher by demand for semiconductors and data-center infrastructure. Four large tech companies — Alphabet, Amazon, Meta Platforms and Microsoft — are expected to invest a combined $720 billion this year, mostly on data centers, according to JPMorgan Chase estimates.
Apple boosted prices for laptops and iPads by about 15 percent to 25 percent last month, citing component cost increases. Microsoft announced a $100 price increase for its Xbox console, effective Aug. 1, while Dell and HP have raised laptop prices. Economists at Evercore ISI described the situation as "a wave of AI-related cost pressures spilling over into consumer prices" that is still in its early stages.
The AI investment cycle is also feeding through to electricity costs. Power prices rose 5.9 percent in May from a year earlier, outpacing the 4.2 percent headline inflation rate. Goldman Sachs economists forecast electricity prices will rise 6 percent this year and next, with above-average increases continuing into 2028.
The labor market is stable, but supply growth has collapsed
The unemployment rate stood at 4.2 percent in June, down from 4.3 percent in May, and has changed little since last summer. Layoffs remain subdued, job openings have stabilized, and private payroll growth improved to nearly 100,000 per month in the second quarter.
Ordinarily, that pace of hiring would look soft. However, immigration has slowed sharply and population aging continues to reduce labor-force participation. With labor supply barely growing, modest job creation is enough to prevent unemployment from rising. Business-sector productivity has grown at an average annual rate of 2.1 percent since late 2019, compared with 1.5 percent during the previous business cycle, which the Fed says makes current wage growth approximately consistent with 2 percent inflation over time.
Even so, aggregate wages have failed to keep pace with the latest rise in consumer prices, with real wage growth turning negative. The saving rate has fallen to 3.9 percent, auto-loan delinquencies have risen among lower- and moderate-income borrowers, and consumer sentiment remains weak.
What happens next
Waller's comments align with a broader hawkish shift under new Chairman Kevin Warsh, who took office May 22 and has repeatedly stated that the Committee "will deliver price stability." Warsh's voting record as an FOMC member has historically been hawkish, and his public statements have emphasized the Fed's independence from fiscal considerations.
"Monetary policy must remain independent, focused on our economic objectives," Waller said, pushing back against President Donald Trump's repeated calls for lower rates. "We are not going to keep rates down just to help the government finance its deficits."
The July 14 CPI report will be the critical data point. If core inflation shows further acceleration, the probability of a July hike will rise sharply. If it moderates, the Fed may hold steady while keeping the door open for a September move. Either way, the debate is no longer about when the Fed will cut — it is about when it will hike.
This article is for informational purposes only and does not constitute investment advice.
