When Waller Speaks…

This morning, stocks are off to the races.  Quite frankly, the rationale seems a bit tenuous. The most likely reason for the enthusiasm is the commentary offered by Federal Reserve Governor Christopher Waller, which implied he would be willing to support keeping rates on hold in September.  Yields fell, reflecting the lower likelihood of near-term rate hikes, but other assets had significant moves as well.  Investors need little to spur them to take risks, even ahead of a jobs report tomorrow morning.

Besides seeing the S&P 500 (SPX) and Nasdaq 100 (NDX) both up by about 1% just before noon ET, we have the Japanese currency strengthening by about 3 yen, bitcoin rising by about $3,500, and Treasury rates declining by 3-4 basis points across the curve.  That’s an awful lot to attribute to a single set of comments by a single Fed Governor. 

It seems relevant to parse Waller’s comments.  Taken literally, they appear to be those of the classic two-handed economist, if not a “Goldilocks” approach.  But as we saw numerous times during former Chair Powell’s press conferences and speeches, investors hear what they want to hear.  See if you can figure out which of Waller’s comments were taken to heart and which were ignored [emphasis added]:

This leads me to my outlook for monetary policy, which I previewed at the beginning of these remarks. As of today, the labor market is stable, with employment near its maximum sustainable level, and inflation is making slow but continued progress on reaching 2 percent. We will get another employment report and inflation reading before the next FOMC meeting. I don’t expect that the employment data will deviate much from what we have been seeing. So my decision on the appropriate stance of policy will be heavily influenced by what we learn about August inflation. If there is continued progress toward our 2 percent goal, then I am willing to support holding the policy rate at its current level.

But if inflation comes in hot, I would consider a rate hike. I judge that policy is currently only slightly restricting aggregate demand, and it may not take much acceleration in inflation to nudge me into supporting tighter policy. If there is evidence that progress toward 2 percent inflation reversed in August, a small adjustment in our stance would help ensure that it resumes.

Thus, if inflation is tame, he will advocate for keeping rates stable, but if it’s high, he’ll consider a hike.  Perhaps there is a matter of degree here?  Waller will “support” no change if inflation is moving in the right direction but only “consider” a hike if not.  Either way, it sounds as though the rate decision, at least from the point of view of one influential Governor, will come down to the PPI and CPI reports that are due on September 10^th and 11^th, respectively. 

Regardless of whether the market is overemphasizing one set of comments or placing a sizeable bet on quiescent inflation reports, we can see that rate hike expectations plunged this morning.  They haven’t reverted completely to the levels that prevailed before Chair Warsh’s Jackson Hole speech, but they are much more reflective of a coin-flip than they were previously.   Before Warsh’s speech, the CME FedWatch showed that a 36% chance for a hike was priced into the futures market.  That jumped to 58% after the speech, rose to as high as 68% on Tuesday, and are now back to about 50% today.  IBKR Prediction Markets have consistently been more sanguine than CME prices and remain so today.  They show only a 41% “Yes” for a hike at the September meeting.

Source: IBKR Prediction Markets

As far as the economic report that looms tomorrow, expectations continue to show a steady, if not robust, labor picture.  Economist consensus calls for a rise of 55,000 in Nonfarm Payrolls, up from last month’s drop of 23,000, while the Unemployment Rate is expected to remain steady at 4.1%.  IBKR Prediction Markets generally agree with the economists, showing a 48% “Yes” for Nonfarm Payrolls above 50,000 and a 49% “Yes” for Unemployment above 4.1%

Part of today’s enthusiasm might also stem from Waller’s relatively sanguine, if not dismissive, comments about the labor market overall and tomorrow’s report specifically.

Turning to the labor market, it is also in satisfactory shape… Layoffs and initial claims for unemployment insurance are likewise low. I expect more of the same tomorrow when we get the August employment report.

With economic activity and the labor market in good shape, they are not a large factor in my determination of the appropriate setting of monetary policy. 

It appears that many have decided that if Waller is unconcerned, then so too should they be.  SPX options show almost no excess volatility priced into options expiring tomorrow.  The at-money implied volatility for SPX options expiring tomorrow is 0.75%, slightly above the 0.72% priced into options expiring next Friday and the 0.64% priced into options expiring on September 18^th.  Considering we now know how important next week’s inflation reports will be to at least one Fed Governor, and that the FOMC meeting on the 16^th is basically a coin toss right now, the pricing seems relatively calm.  It’s clear from days like today that missing a rally remains a bigger concern than downside risk.