With the Federal Reserve’s Jackson Hole gathering approaching in August, markets are zeroing in on Chair Waller’s policy framework and on whether the September meeting could bring a rate move stronger than current pricing suggests. In a report cited by Li Jia of The Wall Street Journal, Morgan Stanley said Waller’s first press conference delivered a message that was clear on the destination but vague on the route.
A clear inflation goal, but no explicit path
Morgan Stanley said Waller has been deliberately changing the way the Fed communicates with markets. The message, in the bank’s view, has three fixed elements: inflation is still running too high, policy is aimed at bringing inflation back to target, and the Fed remains confident that it can get there.
The unresolved question is how, exactly, the central bank intends to achieve that outcome. According to the report, that missing piece is likely to define market debate over the coming weeks. The focus is whether Waller would choose to tighten policy more actively if financial conditions continue to tighten but still fail to curb inflation.
Morgan Stanley says Waller is widening the gap with market expectations
After reviewing Waller’s earlier remarks at Federal Open Market Committee, or FOMC, meetings, Morgan Stanley concluded that he is intentionally putting more distance between the Fed’s policy stance and market expectations.
The bank said Waller keeps returning to three dimensions: his reading of past inflation, which is that price pressures remain elevated; his forward policy objective, which is to return inflation to target; and his confidence in reaching that objective. What this framework does not do is tell investors what specific steps the Fed will take next.
That marks a shift from the Fed’s older communication style. In the past, forward guidance often helped markets shape expectations around policy. Waller, by contrast, appears more willing to let markets make their own judgment about the economy and about the path the Fed may ultimately choose. Morgan Stanley said he does not appear concerned about divergence between market views and the Fed’s own thinking, nor is he inclined to adjust policy positioning simply to align with investor expectations.
Tighter financial conditions do not guarantee inaction
The FOMC paused rate hikes in July, and one important backdrop was that financial conditions had already tightened in advance. Higher market rates and adjustments in asset prices had absorbed part of the tightening effect that would otherwise come from monetary policy, and Waller appeared to acknowledge that.
Still, Morgan Stanley said markets should not jump to the conclusion that tighter financial conditions automatically mean less Fed action. In the bank’s reading, Waller does not see market-driven tightening as a full substitute for central bank policy. What matters more is whether those tighter conditions are actually reducing inflation pressure, not whether market indicators have merely moved.
If upcoming data show that tighter financial conditions have failed to cool inflation effectively, Waller could decide to act again. Morgan Stanley said this is one reason he has avoided offering a firm policy path: preserving room for flexibility.
Markets price in 25 basis points for September, but a tougher outcome remains a risk
Markets have broadly priced in a 25-basis-point rate increase at the September meeting. Morgan Stanley warned, however, that inflation data over the next two months could upset that view.
If inflation readings for July and August continue to come in above expectations, investors could start pricing a more aggressive tightening path. The report said markets may conclude that the earlier tightening in financial conditions was not enough to restrain demand and that the Fed would need to apply additional pressure through actual rate increases.
In that scenario, Waller’s policy choice in September could look materially different from the July decision. He may judge that market conditions still have not become restrictive enough and opt for action that is more hawkish than what current market pricing implies.
Morgan Stanley said this is one of the largest tail risks now facing the rates market. As Jackson Hole draws closer, investors will keep parsing Waller’s remarks for clues about the Fed’s reaction function and for signs of how likely a September rate increase may be.