Federal Reserve Governor Christopher Waller indicated on Monday that the central bank's risk assessment has shifted, with inflation now posing a greater threat than labor market weakness. This change in tone comes ahead of the July 28-29 Federal Open Market Committee (FOMC) meeting, where a rate hike is increasingly being considered.
Speaking at a Bank of Italy event in Rome, Waller noted that the balance of risks has "completely flipped around" from a year ago. He observed that the labor market "seems to be stabilizing," while inflation continues to run above target. Although Waller did not explicitly advocate for a specific rate move, his remarks underscored the growing concern over price pressures.
The Fed's June projections painted a more hawkish picture than previously anticipated. The central bank now sees 2026 PCE inflation at 3.6%, a significant upward revision from the 2.7% estimate in March. Core PCE inflation was also raised to 3.3% from 2.7%. Consequently, the median projection for the federal funds rate in 2026 increased to 3.8% from 3.4%.
Market participants are pricing in roughly a 25% probability of a 25-basis-point rate hike at the July meeting, according to CME Group's FedWatch tool. The dot plot from June revealed a divided committee, with 9 out of 18 participants projecting rates above the current 3.625% midpoint, and six seeing at least two hikes by year-end. This dispersion highlights the uncertainty surrounding the policy path.
Waller emphasized the importance of credible communication. He pointed out that forward guidance can be effective but warned that overly rigid guidance in 2021 "tied the hands" of the Fed, delaying necessary rate hikes. "In some cases, it's best not to use it at all," he said, suggesting that the Fed should retain flexibility.
The Fed held its funds target range at 3.50%-3.75% in June, but the updated projections indicate a higher inflation trajectory and a more aggressive policy outlook. The shift in the Fed's risk assessment has implications for various asset classes. Rate-sensitive tech and semiconductor stocks have been driving equity gains, with Broadcom (AVGO) jumping 3.8% after renewing its custom-chip supply contract with Apple (AAPL) through 2031. Meanwhile, Microsoft (MSFT) dropped 1.2% after announcing plans to cut approximately 4,800 jobs.
Tim Duy, chief U.S. economist at SGH Macro Advisors, stated that "a rate hike is on the table" for July, given low unemployment and inflation still above target. "This shouldn't be a debate anymore," Duy wrote, reflecting growing conviction among some economists.
The next major inflation data point will be June's Consumer Price Index (CPI) report, due on July 14, which will be the last key reading before the Fed's July meeting. Oil prices hovering near $70 per barrel could help moderate headline inflation, but Fed officials in June still projected year-end PCE inflation more than a point above their 2% target.
