• Federal Reserve Governor Christopher Waller signals a shift in risk assessment, noting the labor market has stabilized while inflation is accelerating.
  • The changing dynamics could alter the monetary policy debate, potentially delaying or reshaping the pace of rate cuts.
  • Markets now weigh the implications of a more cautious Fed amid conflicting signals on employment and prices.

Federal Reserve Governor Christopher Waller on Thursday highlighted a notable shift in the balance of risks facing the U.S. economy, saying that while the labor market appears “stabilized,” inflation has “been taking off,” fundamentally changing how policymakers should think about the appropriate path for interest rates. Speaking at a conference in Washington, Waller remarked that “risks have flipped around,” suggesting that recent data showing stubborn price pressures may now warrant greater attention relative to concerns about a softening jobs market.

His comments come as the Fed navigates a complex landscape: the latest payroll figures showed employers added 272,000 new jobs in May, well above expectations, while the unemployment rate held at 4.0%. At the same time, the personal consumption expenditures price index—the Fed’s preferred inflation gauge—rose 2.8% in April from a year ago, with core readings still hovering above 3%. Waller noted that “we have not seen the kind of progress on inflation that we had hoped for in the first part of the year,” echoing remarks from Chair Jerome Powell and other officials who have stressed the need for more evidence that price gains are sustainably returning to the 2% target.

According to people familiar with the matter, the shift in Waller’s tone has caught the attention of traders, who are now reassessing the likelihood of rate cuts later this year. Prior to the speech, futures markets had priced in about two quarter-point reductions by December; after his comments, those odds edged lower, with the first full cut now not fully discounted until November. “Waller has been one of the more hawkish members, but this is a clear signal that the committee is preparing to hold rates higher for longer,” said a senior economist at a major Wall Street bank who asked not to be named due to confidentiality policies.

The governor’s assessment of the labor market, which he described as “stabilized” rather than “softening,” stands in contrast to some earlier concerns that rapid rate hikes might cause excessive damage to employment. Since March 2022, the Fed has raised its benchmark rate by 5.25 percentage points to a range of 5.25% to 5.5%—the highest in 23 years. While job gains have moderated from the red-hot pace of 2022, the economy continues to add jobs, and wage growth, while slowing, remains above pre-pandemic norms. “The labor market is still tight, but not over-heating,” Waller said, indicating that the balance between supply and demand has improved.

On the inflation front, Waller pointed to a string of disappointing readings in early 2024, including a resurgence in goods prices and sticky services costs. He suggested that tariffs—which have risen on goods from China and are likely to increase under current trade policies—could be feeding through to consumer prices. “We need to be careful not to be fooled by temporary declines,” he warned, urging patience before easing policy. His remarks align with data from a recent Institute for Supply Management survey showing that a growing share of manufacturers are reporting higher prices paid for inputs.

The implications for financial markets are significant. Bond yields, which had been falling on expectations of rate cuts, reversed course after Waller’s speech, with the 10-year Treasury note rising six basis points to 4.32%. The dollar strengthened against a basket of currencies as traders repriced the trajectory of U.S. rates. Meanwhile, stock indices trimmed earlier gains, with the S&P 500 ending the session down 0.2%.

Economic analysts are now debating whether the Fed’s next move might be a hike rather than a cut. While most still see the next change as a reduction, some hedge fund managers have begun positioning for a scenario where inflation reaccelerates, forcing the central bank to go back on hold or even tighten. “Waller’s comments are a wake-up call that the ‘transitory’ narrative is dead for good,” said a portfolio manager at a Connecticut-based macro fund. “The market has been too complacent about the possibility of no cuts this year, or even a small hike.”

Outside the Fed, global central banks are also recalibrating. The European Central Bank delivered a quarter-point cut in June, but ECB President Christine Lagarde cautioned that further moves would depend on data. In the UK, the Bank of England kept rates unchanged at 5.25% as services inflation remained above 5%. The synchronized move toward caution reinforces the idea that the post-pandemic battle against inflation is far from over.

Correction: An earlier version of this article stated that Waller spoke on Wednesday; the speech actually took place on Thursday.