How does Wall Street view Wash Jackson Hole's debut? Hawkish "correction" in July communication, not raising interest rates in September may further damage the Federal Reserve's credibility

Author: Wall Street Journal

Federal Reserve Chairman Waller's debut at the Jackson Hole annual meeting on Friday was widely interpreted by Wall Street as a "hawkish correction" to the communication following the July FOMC meeting.

Waller's speech clearly reaffirmed that the 2% inflation target of the Federal Reserve is unwavering, stating that current overall financial conditions cannot be deemed restrictive, and that the recent better PCE and CPI data are insufficient to prove a substantial improvement in underlying inflation trends. He bluntly stated that if there is no certainty that inflation is declining at a "clear and sufficiently fast" pace, the Federal Reserve "still has work to do." Reuters reported that this was Waller's closest acknowledgment yet that rate hikes may be necessary.

Waller's remarks quickly shifted Wall Street's focus on the September FOMC meeting. Priya Misra, an investor at JPMorgan Asset Management, directly called it a "hawkish speech," believing that Waller was strongly reaffirming the Federal Reserve's commitment to price stability and viewing it as a "cleanup" of the "communication error" from the July press conference. Aberdeen's investment director Matthew Amis warned that if the Federal Reserve does not raise rates in September, its credibility may be further damaged.

Both Barclays and Société Générale adjusted their forecasts for Federal Reserve policy based on Waller's speech at the Jackson Hole seminar, expecting a 25 basis point rate hike in both September and December. Société Générale also anticipated another rate hike in March.

Institutions like Wells Fargo and Fidelis Capital believe that Waller's speech has left enough room for a rate hike in the near term, but some institutions argue that he still did not provide a clear policy path for action in September.

Journalist Nick Timiraos, known as the "New Federal Reserve Correspondent," pointed out the crux of the debate: Waller believes that financial conditions are not restrictive, and the recent improvement in inflation data has not convinced him that there has been a "meaningful improvement" in underlying trends, yet he did not provide a specific policy path nor explicitly state whether he supports a rate hike in September. Timiraos summarized Waller's speech as indicating that the Federal Reserve may not yet be done fighting inflation.

Thus, the market is faced with a more hawkish policy diagnosis but still lacks a clear "reaction function." CME data shows that after Waller's speech, the probability of a rate hike in September rose from about 35% before the speech to around 50%; other market data even indicated a further increase to about 60%.

Hawkish Speech Restores Anti-Inflation Credibility

Waller's speech primarily accomplished a "correction" in policy communication.

Priya Misra from JPMorgan Asset Management had a very straightforward assessment of Waller's speech:

"This is a hawkish speech."

She believes that Waller was "strongly indicating" that policymakers are committed to price stability. Misra is more concerned about the relationship between Waller's speech and the communication following the July FOMC meeting. She described this speech as a strong response to what she believes was a communication failure at the July press conference:

"This is a strong response to what I think was a communication failure at the July press conference."

She even referred to it as a "clean-up act," a "final correction" of the July communication.

This point was echoed by others in the industry.

Christopher Hodge, Chief U.S. Economist at Natixis, believes that Waller's speech represents a "clear improvement" compared to the July press conference, where the market underestimated the likelihood of a Federal Reserve rate hike, and the current pricing is now more reasonable.

Hodge believes that by directly acknowledging the inflation issue, reaffirming the clear 2% target, and taking responsibility for the Federal Reserve's institutional role in inflation matters, Waller has strengthened his anti-inflation credibility.

Mark Hackett, Chief Market Strategist at Nationwide, believes that Waller successfully achieved his goal: to convey his position to the market without significantly disrupting it.

Hackett pointed out that there was a previous misjudgment in the market, which thought the 2% inflation target might have softened, but Waller has now clearly told the market that this will not happen.

"He is reaffirming a hawkish stance in a more consistent manner, rather than a sudden escalation."

Hackett even summarized it as:

Do not expect rate cuts soon; be prepared for rate hikes.

The "New Federal Reserve Correspondent" Highlights Key Points: Financial Conditions Not Restrictive, Inflation Improvement Still Insufficient

Timiraos's summary of Waller's speech is more focused on the policy judgment itself.

He pointed out that Waller believes overall financial conditions are not restrictive, and the credit and loan markets show almost no signs of significant constraints; at the same time, the recent better inflation data has not convinced Waller that the underlying trend has improved.

Waller's exact words were:

"I find it hard to describe overall financial conditions as restrictive."

Regarding the recent inflation data, Waller stated:

"While the PCE and CPI data this summer have been better than expected, that does not lead me to believe that the underlying trend has shown meaningful improvement."

Timiraos specifically highlighted this statement in his reporting and on social media.

In his view, this means that the market cannot assume that Waller has shifted to a more accommodative policy stance simply because inflation data has been better than expected in recent months. What Waller is truly concerned about is whether the underlying inflation trend is moving toward the 2% target at a sustained and sufficiently fast pace.

Waller Provides a Compass, Not a GPS

Another distinct feature of Waller's speech is that he clearly told the market his policy principles but refused to provide a specific policy reaction function.

Nathan Shetty, Chief Investment Officer at SEI Investments, believes that Waller's clear reaffirmation of the 2% PCE target is firm, thus the speech can only be understood as more hawkish.

However, Ellen Hazen, Chief Market Strategist at F.L. Putnam Investment Management, pointed out that Waller did not disclose the Federal Reserve's reaction function, leaving the market in a "black box" state.

Waller himself explained that excessive disclosure of the policy reaction function could, in turn, constrain the Federal Reserve, much like the over-reliance on forward guidance in 2021.

Hazen believes this means Waller wants the Federal Reserve to maintain greater flexibility in the face of economic changes, but the market may not favor this approach.

Peter Andersen, founder of Andersen Capital, used a vivid metaphor:

Investors want a GPS, but the Federal Reserve is providing a compass.

In his view, investors hope Waller will explain the economic outlook and policy path in detail, but Waller is actually telling the market: the new Federal Reserve will not provide as much forward guidance as previous chairs, and the market must adapt to this "new regime."

"If there is no rate hike in September, credibility will take another hit": Wall Street Begins to Rebet on Near-Term Action

For the market, the most significant change is that the September rate hike has moved from the periphery to the core discussion.

Matthew Amis, investment director at Aberdeen, believes that Waller's speech has set a critical scene for the September meeting:

"If they do not raise rates, credibility will take another hit."

This statement effectively links Waller's anti-inflation remarks with the September policy action: since Waller has clearly stated that underlying inflation must decline at a sufficiently fast pace, otherwise the Federal Reserve "still has work to do," if future data does not show significant improvement and the Federal Reserve remains inactive in September, the market may question the actual policy weight of the Federal Reserve's previous hawkish statements.

Gary Schlossberg, global strategist at Wells Fargo Investment Institute, also believes that although Waller did not say it directly, by "connecting all the dots," he has effectively released signals for at least one rate hike, if not more.

He stated that unless inflation declines significantly—something he does not expect to happen—inflation pressures may even increase further in the next 6 to 8 months. Even if there is no rate hike in September, he believes the Federal Reserve is likely to take action early in the year.

Chris Gunster, head of fixed income at Fidelis Capital, explicitly stated that the market now believes the probability of a rate hike in September exceeds 50%.

He believes that several factors mentioned by Waller—inflation still above target, a robust labor market, and resilient economic performance—collectively provide the Federal Reserve with the policy space for a near-term rate hike.

Barclays and Société Générale Expect Rate Hikes in September and December

Both Barclays and Société Générale expect the Federal Reserve to raise rates by 25 basis points at the meetings in September and December.

Barclays' prediction from mid-June was to "maintain rates unchanged indefinitely."

Following Waller's speech on Friday, Marc Giannoni, Chief U.S. Economist at Barclays, and Jonathan Millar, Senior Economist, wrote in a report: "We expect the majority of FOMC members to align with Waller's position and raise rates by 25 basis points in September, as the progress made on inflation is insufficient."

These economists expect "another 25 basis point hike in December, raising the target range for the federal funds rate to 4.00%-4.25%, as there has been almost no progress in year-on-year inflation for the remainder of the year."

Jan Groen, Chief U.S. Economist at Société Générale, stated in a report: "Persistently stubborn core inflation and the Federal Reserve's increasingly clear concerns about high inflation indicate that the threshold for maintaining rates unchanged is rising."

Although Société Générale expects the Federal Reserve to raise rates in March next year, Groen noted in the report that the March hike "faces significant uncertainty and may not materialize."

"Short-end says to raise rates, but long-end remains calm": Market Transforms Waller's Diagnosis into Trades

After Waller's speech, the U.S. Treasury market reacted quickly, particularly at the short end.

Reuters reported that the two-year Treasury yield briefly rose by 11 basis points to 4.34%, reaching a one-month high; the ten-year yield rose by 5 basis points to 4.72%, while the thirty-year yield saw a significantly smaller increase.

This performance itself is an interpretation of the market's response to Waller's speech: traders are raising their pricing for near-term policy rate increases.

Michael Rosen believes that the decline in short-end Treasuries and the rise in long-end Treasuries reflect that the market is reassessing the Federal Reserve's policy direction—a Federal Reserve that views inflation as a primary issue implies that short-term rates may still rise further.

Chris Gunster from Fidelis Capital similarly pointed out that the rise in short-end yields and the decline in long-end yields are flattening the yield curve, which aligns with the market beginning to bet on a Federal Reserve rate hike.

However, this market reaction does not mean that Wall Street has formed a consensus on a "must hike in September."

Peter Cardillo, Chief Market Economist at Spartan Capital, believes that the Federal Reserve may not take action in September.

He argues that Waller has acknowledged that summer inflation data has improved, but it is still "not convincing," so the Federal Reserve may want to observe the inflation data for September and October before deciding whether to act.

In other words, the market is repricing for a rate hike, but data remains the final threshold determining whether there will actually be a rate hike in September.

Waller Continues to Deliberately Reject Forward Guidance: "Said a Lot but with Little Substance"

Not all institutions believe that Waller's speech has completed a "thorough repair" in policy communication.

Eugene Epstein, head of trading and structured products at Moneycorp, believes that although Waller's speech initially appeared hawkish, the substantive content remains limited.

His assessment is very sharp:

"Waller said a lot, but it seems there is not much substance to those words."

Epstein believes that Waller has previously released similar hawkish signals before multiple FOMC meetings, but the subsequent policy actions did not follow.

Therefore, he is concerned that the market may again experience a situation where it is "first driven by hawkish speeches, only to find no actual policy changes."

Jamie Cox, managing partner at Harris Financial Group, summarized this style as:

"Waller said a lot, but said nothing at all."

He believes that Waller is trying to walk a middle path, aiming to reinforce anti-inflation credibility while unwilling to constrain future policy through forward guidance.

This is precisely where the metaphor of "providing a compass, not a GPS" is most appropriate: Waller is willing to tell the market what kind of data would prompt the Federal Reserve to act, but is unwilling to tell the market which specific meeting will take action.

The Real Risk of "No Rate Hike in September": Not the Policy Itself, but Credibility

Overall, the most noteworthy aspect of Waller's speech, according to Wall Street professionals, is not that he has promised the market a rate hike in September, but that he has reestablished a more hawkish policy logic:

If employment remains robust, the economy remains resilient, and underlying inflation does not decline sufficiently fast toward the 2% target, then current financial conditions may not be restrictive, and the Federal Reserve cannot rule out the possibility of further increasing policy rates.

This is also why Amis believes that if there is no rate hike in September, it could actually cause new damage to the Federal Reserve's credibility.

On the other hand, the views of Cardillo, Epstein, and others also remind the market: hawkish communication does not equate to policy decisions.

Waller still adheres to the principle of "not providing forward guidance," has not explicitly committed to a rate hike in September, nor provided a mechanical policy reaction function.

Therefore, the more accurate consensus forming on Wall Street may be:

Waller has completed a hawkish correction of the communication from July through his speech at Jackson Hole; the probability of a rate hike in September has significantly increased, but whether a rate hike will actually occur will still depend on the upcoming employment and inflation data.

For Waller, the real policy test has shifted from "whether the market understands his speech" to a more direct question: if the data does not show significant improvement, is he willing to translate this hawkish diagnosis into an actual rate hike in September.