Observations: Nerd King Waller
He’s not a hawk, but he is the one to listen to this week
Policy signal? Or distraction?
Somewhat ironically, because I “grew up” as an economist inside perhaps the three most important economic policy institutions in the world – the Federal Reserve Board, the Bank for International Settlements, and the US Treasury Department – policymakers’ communications play very little role in the formulation of my views. I do not traffic in “access” to officials, despite knowing many personally, and in fact, I generally try to avoid talking to them or even reading their speeches. The reason is simple: over the last two decades I have consistently forecast the economy and markets better than them, and because I know how they think, I can better predict their policies than they do.
But there are occasions where it makes sense to pay attention to the people making the decisions, notably when they deviate from the script, i.e. make a policy error. The September employment and CPI reports put a double exclamation point on my contention that the Fed made a clear policy error in September (The Fed fumbles), implying that the Fed will not cut anywhere near as much as markets now price for next year. While no one on the Federal Open Market Committee (FOMC) will ever admit that it was an error to cut so aggressively, it is an open question how quickly they will back away from the scene of the crime. Will they cut rates again this year? And if so, at both the November and December meetings?
Why I’m listening to Governor Waller
As I will cover in a forthcoming note, the PCE report on Halloween, the employment report two days later, and the US election result (yes) on 5 November will have the most bearing on those questions, but in the interim, parsing carefully the words of FOMC speakers may offer clues as to whether and how quickly the Fed will distance itself from the policy error. As I will argue, the most deserving of your attention is Federal Reserve Governor Waller who will speak twice this week (Monday and Friday), hence this brief note explaining why he’s important and what to listen for. I also am making this note freely available since I owe the analogical framework I use in it to one of my mentors who was always freely giving to me of his wisdom.
I have been blessed in life by some amazing mentors. One of the best, Vince Reinhart, is still the best Fed watcher I know. No one knows the Fed as an institution, its inner workings, its policy instincts, and its psychology better than Vince. For almost two decades now, I have used his “Fed High School cafeteria” analogy to analyze Fed speakers and judge the insights that they offer.
Life at the Fed High School cafeteria
Vince likens the FOMC to an American high school lunch cafeteria and the cliques that form at its tables. In any American high school, there are four clear groups at different tables: the cool kids, the jocks, the geeks, and the nerds:
The cool kids of the FOMC are cool because they have important titles, e.g. the Chair and Vice Chairs, both of the FOMC, i.e. the President of the New York Fed, and of the Board of Governors. But those with titles may also make others cool by inviting them to sit at their table.
The Committee’s jocks are the simpletons who know only one thing: “Fight inflation! Fight inflation! Go team!”
The Geeks are the FOMC members who are in love with their models and will never deviate from them.
The Nerds are those FOMC members who are desperate to be invited to sit at the cool kids table and, because no one likes desperate people, never will.1
The cool kids won’t talk to you
The beauty of the “Fed cafeteria” framework is that it tells you exactly who you need to pay attention to and who you can safely ignore. It seems obvious, given that they drive the Committee’s decisions, that you really want to pay attention to the cool kids. But that’s wrong. The cool kids will never deviate from the party line outside of school because they control it: the policy Statement, the Minutes, Congressional testimony, and rare policy course changes by the Chair in prepared, well-telegraphed speeches all reflect their established consensus. If you want additional insight you need to listen in on the cool kids’ lunchtime conversations.
Nota Bene: This is why it is a waste of time listening to people who purport to “talk to” the Fed, or who attend the Jackson Hole meetings, the Treasury Borrowing Advisory Committee (TBAC), or other such fora that allow you to hobnob with FOMC members: the cool kids didn’t get those titles by being stupid enough to selectively (and potentially illegally) disclose school gossip “outside school.”
Jocks and Geeks are boring
But there are students at Fed High who do overhear the cool kids’ lunchtime discussions: the Jocks, the Geeks and the Nerds! The first two groups, the Jocks and the Geeks are not worth listening to. The Jocks have only one message ever: “Fight inflation!” You don’t need to pay attention to the Geeks either: their models (usually published in Fed working papers and endlessly detailed in their speeches) tell you exactly how they’ll vote, and because they aren’t interested in the discussion at the cool kids’ table, they won’t drop any hints to you in their own speeches.
Nerds like to watch...and tell
But there is a clique in the cafeteria that is both intently eavesdropping on the conversation at the cool kids’ table, desperately hoping to be invited to join, and indiscrete: the Nerds. Just like their high school counterparts, in their desperation, the FOMC’s Nerds often make the error of thinking that the cool kids might invite them to join if they pretend that they are part of the conversation, even to parents outside of school. This is why the most important group to pay attention to is the Nerds. Not because they have any influence within the Committee – they never do – but because they hear what you cannot and often let slip in their speeches and interviews where the cool kids may be leaning in their lunchtime conversations.
James Bullard passes the crown
So, who are these Nerds? For years the King of the Nerds was St. Louis Fed President James Bullard, a man so desperate to look cool he even invited CNBC’s Squawk Box to broadcast live from within the St. Louis Fed.2 Since Mr. Bullard’s retirement a year ago, the crown of King of the Nerds appears to have been passed to his apprentice and former director of research at the St. Louis Fed, Governor Christopher Waller. While Governor Waller hasn’t invited CNBC down to the Eccles Building in Washington, he has reliably signalled where the Committee may be going:
Even as inflation was surging in mid 2021, Governor Waller gave no hint that he was a hawk, but as the need for tightening became closer to consensus in late 2021, he joined his mentor, President Bullard, in pushing for tighter policy.3
It was Governor Waller that first signalled the Fed’s (erroneous) pivot towards easing policy in late 2023 in a speech at the American Enterprise Institute.4
At the September FOMC meeting, he joined the majority of the Committee in voting for a 50bp policy cut despite inflation being above target and growth continuing to outpace the Committee’s implied estimate of potential.
Based on these flipflops, I jokingly nicknamed Governor Waller “Two Face” from the Batman comic books. But I think they also well establish him as the preeminent Nerd to pay attention to on the FOMC. (Note: These characterizations are wholly my own and are in no way reflective of Vince Reinhart.)
When Waller speaks, what do you hear?
So, what should we be listening for? President Raphael Bostic of the Atlanta Fed, already opened the door to “maybe we should take a pause in November,” even going so far as to note that his “dot” in the latest Summary of Economic Projections (SEP) embeds only 25bp of cuts through yearend “if the data comes in as I expect.”5 President Bostic’s position gives Governor Waller the room to go at least as far, perhaps even further if he senses that the cool kids are wavering on a further 50bp of cuts this year after recent data. If he does, both the 87.5% chance of a 25bp cut at the November meeting and the 91% chance of 50bp of cuts by yearend look overpriced by markets.
Could Governor Waller go further? His early call for a pivot last year and front-running of multiple 50bp hikes in March 2022 suggest that he could. Both President Bostic and cool kid New York Fed President John Williams defended their votes for 50bp in September as justified by the “very restrictive stance” of policy and waved away the September employment report (and CPI report in Mr. Bostic’s case) as “janky” data in “one or two labour reports.”6 If instead Mr. Waller characterizes pre-September policy as “mildly” restrictive or suggests that the combined effect of the September employment and CPI reports call into question how quickly inflation will return to target, then it may suggest that there is serious discussion within the Committee of staying on hold through yearend.
Conversely, if Governor Waller is more timid than President Bostic in discussing the potential for a November pause, especially if he characterizes policy as “very” or “meaningfully” tight as President Williams does, then it suggests that the key leaders on the Committee are still committed to cutting 50bp by yearend in line with the median SEP projection. Given the data and event risks I’ll discuss in my next piece, it still makes sense to be paid US interest rates next year (or short 2y Treasuries), but this tone by Mr. Waller would suggest that the risk/reward of selling November or December Fed funds futures is less favorable.
When Vince taught me the “cafeteria” framework, there were no real “doves” on the Committee and, reasonably then, with the Great Inflation of the 1960s to early 1980s still fresh in economists’ minds, his framework omitted their very potential. But, I think Vince’s framework could use updating. For instance, I add “Teachers Pets” and “Misunderstood Youth” as counterparts to the Jocks: doves you can safely ignore the speech of. I’ll let readers come to their own conclusions as to who would fit in each new clique.
“Live from the St. Louis Federal Reserve, it’s ‘Squawk Box’ – and a lesson in economics,” Mary Delach Leonard, St. Louis Public Radio, 8 October 2010.
Governor Waller was categorized as a “centrist” as late as July 2021: “Hawks vs doves: US Federal Reserve divided over when to dial back economic support,” Colby Smith & James Politi, Financial Times, 26 July 2021; but by November of that year he’d followed (then) Vice Chair (and cool kid) Richard Clarida out of the foxhole by calling for QE to be reduced more quickly: “Investors bet Powell’s Fed will get more aggressive on inflation,” David Randall, Reuters, 23 November 2021; and by January 2022 he was being called a hawk (for advocating a 25bp hike in March!): Tweet by @NickTimiraos, 18 January 2022; before finally, in March 2022 being called “just as hawkish as [his mentor] Bullard” for calling for multiple 50bp moves (two months after he ruled them out): Tweet by @lisaabramowicz, 18 March 2022.
“With Fed likely done hiking rates, Waller flags pivot ahead,” Howard Schneider & Ann Saphir, Reuters, 29 November 2023.
“Fed’s Bostic Keeps Door Open to Skipping Rate Cut in November,” Nick Timiraos, The Wall Street Journal, 10 October 2024.
Ibid, and “John Williams: ‘I don’t want to see the economy weaken’,” Colby Smith, Financial Times (interview), 8 October 2024.