On Friday, Waller, a popular candidate for the next Federal Reserve Chairman and current Federal Reserve Governor, said that he still believes that America's neutral interest rate is relatively low, but warned that unsustainable fiscal spending could change this trend.
Waller said that in the short term, he didn't see anything that would cause him to change his opinion on r*. However, this may change in the future, and this is something that requires close attention.
What Waller said r* means a neutral interest rate. Neutral interest rates are a theoretical concept that describes policy settings that neither stimulate growth nor suppress demand. It cannot be observed in real time, and the estimated range is highly uncertain. Waller pointed out that one important fact about r* is that it is a theoretical concept, and there is no reliable and straightforward method for determining its value.
Long-term neutral interest r* is a central topic of policy discussions among Federal Reserve officials this year. According to the latest estimates released by Federal Reserve officials in March, their estimates of r* range from 2.4%-3.8%.
Currently, senior Federal Reserve officials are wondering if America's neutral interest rate has risen, because the country's economy seems to be less responsive to higher interest rates than they expected. Their median estimate of neutral interest rates in March was 0.6% after adjustment for inflation. The current federal funds rate range is 5.25%-5.5%, while one-year inflation is priced slightly above 2% in the swap market. It is reasonable to say that the Federal Reserve's policy should be strong and restrictive, but the US economy is still growing steadily and is quite resilient.
In his prepared speech, Waller said that America is on an unsustainable fiscal path. If the supply of US Treasury bonds starts growing faster than demand, this will mean falling prices and rising yields, which will put upward pressure on neutral interest rates.
Waller used the US 10-year Treasury yield as an approximation of r* and listed some trends that might drive its decline:
- Lower inflation and economic fluctuations make long-term US debt more attractive.
- The liberalization of global capital markets has increased demand for safe, liquid assets (such as US Treasury bonds), driving down yields.
- Dollar assets held by foreign official institutions (such as central banks and sovereign wealth funds) have increased.
- As retirees need more safe and liquid assets, regulations require banks to hold more liquid securities, and the Federal Reserve itself, demand for US bonds within the US has increased.
In summary, Waller said, “I don't think any of these factors can explain r*'s recent rise, but some of them may contribute to r*'s rise in the future.”
In his speech on Friday, Waller did not express an opinion on the outlook for monetary policy. The latest speech focused mainly on long-term trends. These trends previously lowered interest rates in the US over time, and he also discussed the possibility of a reversal of this trend.
Earlier this week, Waller said that although recent data indicates progress may have resumed in terms of inflation, he needs to see “a few more months” of good inflation data before starting to cut interest rates. If data continues to weaken over the next three to five months, the Federal Reserve may consider cutting interest rates by the end of 2024. Waller said that recent price data shows only moderate progress in achieving the Federal Reserve's 2% inflation target, and he rated the latest US CPI report as C+.
Waller's speech attracted market attention not only because he is a Federal Reserve member with FOMC voting rights. Earlier this year, Nick Timiraos, known as the “New Federal Reserve News Agency,” pointed out that two years ago, Federal Reserve Governor Waller's accurate judgment on the direction of the US economy increased its influence. If Trump is re-elected, Waller may become a strong candidate for the next Federal Reserve Chairman.