Disagreements within the Fed over the direction of policy are growing, particularly between two key figures, Powell and Waller.

Last week, Federal Reserve Chairman Powell and Governor Waller respectively delivered major speeches on the outlook for interest rates. The former continued to show a dovish attitude, saying that if economic activity continues to weaken, the Federal Reserve will cut interest rates. The latter showed a stronger hawkish attitude, saying that recent inflation data were "disappointing" and that there was no need to cut interest rates during the year.

In this regard, the Bank of America Aditya Bhave analyst team issued a research report on Tuesday local time, stating that due to the year-on-year base effect of core PCE inflation, it was favorable until May, but was unfavorable in 6 of the 7 months at the end of the year. of. If the Fed cannot provide a strong case for a rate cut in June, it may have to wait until March 2025 to start cutting interest rates.

Coupled with the fact that inflation remains at a relatively low level, the Bank of America supports Powell's view of retaining the possibility of an interest rate cut in June rather than predicting the data in advance, thereby avoiding the risk of unnecessary tightening of financial markets.

Powell continues to show dovish stance

Bank of America believes that Powell's remarks last Friday were generally balanced, but the overall stance is still dovish. The key issue now is determining the timing of a rate cut rather than the possibility of a rate hike.

Powell's policy response shows a clear asymmetry: The Fed will consider cutting interest rates if economic activity weakens, but it will not shift to a more hawkish stance if economic activity remains strong and inflation does not rise.

By implication, we believe Powell's basic assumption is that strong economic growth in the future will all be driven by the supply side rather than the demand side. Data needs to prove demand is accelerating. This is consistent with Powell's emphasis on the expansion of labor supply.

It is worth noting that although Powell said the Fed is in no rush to cut interest rates, he said core PCE inflation in February was "generally in line with our expectations," suggesting that he is optimistic about the process of lowering inflation.

In other words, the downward trend in inflation has not been disrupted.

Finally, Powell also discussed divergences within the FOMC during Friday's event. Powell said the disagreements were "not an issue" and that "life goes on."

In response, Bank of America wrote:

These comments are interesting because we are starting to see a growing rift in the committee. We believe this is a natural phenomenon, as policy differences tend to amplify as decision points approach.

Waller is full of hawks

Waller took a more hawkish tone in his speech last Wednesday, saying there was no need to cut interest rates this year. He believes that the risk of delaying a rate cut is much lower than cutting rates too early. Waller, unlike Powell and Governor Cook, believes the current policy risks are uneven.

Bank of America pointed out that Waller also paid less attention to supply-side factors and did not even mention the boost to labor supply from immigration and increased labor force participation, but this has been the focus of Powell's discussion.

Waller is more concerned about strong consumption than Powell, possibly because he believes inflation is demand-driven rather than supply-driven.

After Waller's speech, industry insiders analyzed it from different angles. Some people interpreted that Waller believes that the current financial environment is still very tight.

Waller noted that he would be watching the financial conditions index for easing closely as it is largely due to the stock market - specifically the Mag 7. He also noted that the tightening of credit spreads may simply be due to an increase in private credit borrowing.

He believes that the current financial environment is tense because real interest rates remain high. (Powell’s previous speech at the press conference was interpreted by the market as financial conditions may be further relaxed)

Three reasons why divisions within the Fed are intensifying

Bank of America believes that there are three main reasons for the disagreement between Powell and Waller:

First, there is disagreement over whether the dynamics of a strong economy are supply-side (with a deflationary effect) or demand-side (potentially inflationary). In last week's speech, Powell focused on the supply side, while Waller focused on the demand side.

It’s worth mentioning that supply-side issues took center stage at the March Federal Reserve Committee (FOMC) meeting, as evidenced by the summary of economic forecasts:

Growth forecasts for the next three years have been revised up sharply, but inflation and policy rates have risen only modestly and the unemployment rate has barely changed.

Second, there are disagreements over how to balance the Fed's dual goals of returning to its 2% inflation target while ensuring a soft landing.

Some policymakers may be willing to accept a longer path back to 2% inflation to ensure a soft landing. Others may prioritize returning inflation to target, even if it means a greater slowdown in activity.

Third, some policymakers are more worried about possible "jump risks" in policy paths.

Bank of America pointed out that core PCE inflation was favorable through May due to the base effect on a year-over-year basis, but was negative in six of the seven months at the end of the year. If the Fed cannot provide a sufficient reason for a rate cut in June, it may have to wait until March 2025 to start cutting interest rates.

In the three months starting in May, the base effect averaged over 0.3% per month, while from June to December it averaged below 0.2% per month.

For headline PCE inflation, the base effect in the three months ending in May averaged 0.18% per month. In the second half of 2024, this figure is expected to be 0.17% per month.

For the Fed, headline PCE inflation is currently at a relatively low annual rate of 2.5%, while core inflation is at 2.8%. This is a positive sign as inflation remains relatively low.

Will the Fed start cutting interest rates in June?

Does this jump risk mean the Fed should start cutting interest rates in June?

One view is that the Fed should "strike while the iron is hot" and start easing interest rates. Even with three rate cuts this year, rates will still be considered restrictive by most estimates.

Not cutting interest rates this year risks a major financial tightening that could push 10-year yields back to 5% and create heightened concerns about regional banks, commercial real estate and high-yield credit.

Another view is that when financial markets lowered expectations for interest rate cuts earlier, financial conditions did not actually tighten.

At present, Bank of America believes that Powell is more inclined to the first camp than the second camp.

Our view is that he has the ability to convince a majority of the Federal Reserve Board members to support his views. Recalling his comments about divisions within the committee, he seemed comfortable with policy decisions that were not unanimous. Given Powell's dovish stance, this raises the possibility of a possible rate cut in June.

What does this mean for policy forecasts? Bank of America noted:

On a year-over-year basis, demand-driven inflation has remained relatively stable, while supply-side drivers have improved significantly. This is consistent with Powell's view.

However, if viewed from a six-month base period, demand-driven inflation has accelerated in recent months, which is more in line with Waller's concerns, although the calculation of six-month growth rates may be affected by seasonal factors.


Taking all things into consideration, Bank of America maintains its forecast for three interest rate cuts this year, with interest rate cuts expected to begin in June. But if there are increases of 30 basis points or more in the next two core PCE numbers, especially if economic activity remains strong, then the likelihood of a rate cut in June may become less likely.