The Odyssey Toward 2 Percent

Research evidence excerpt

The Odyssey Toward 2 Percent

IdeaMIn fact, Waller cited three reasons why he believed the current environment was different

than what occurred in 2021 and 2022:

1. The labor market is not as tight; the vacancy rate is at 1.0;

2. Nominal wage growth aligns with 2% inflation, due to higher labor productivity;

3. Inflation expectations remain anchored

However, market participants interpreted his remarks about needing to consider

tightening monetary policy in the term as hawkish, but failed to realize this view was

conditioned on another hot reading on core inflation.

Indeed, Waller's own baseline for core inflation calls for a deceleration because two

factors driving upward pressure on inflation are expected to recede:

1. Tariffs: Federal Reserve research finds that the effects of import tariffs on goods

prices were relatively modest and that the vast majority of the effect on inflation

of that one-time adjustment in the price level is mostly over.

2. Energy: Earlier concerns that higher oil prices could be passed through to inflation

for other goods and services have greatly diminished, based on inflation data so

far and the recent fall in oil prices.

Exhibit 1: Market pricing for the July FOMC Exhibit 2: Cleveland Fed: Trimmed mean CPI m/m

meeting from 7/13 at 8:00am ET to 7/17 at 8:00am % change over the last year

ET % m/m change

0.45 0.43 Basis points

14 Waller's 0.40

June CPI

Speech

0.35

12 0.30

0.30 0.28

0.25 0.25 0.26 10 0.23

0.25

0.20 0.19 0.19

8 0.20

0.15 0.15

0.15

0.10

4 0.05 0.01

0.00

Jun-25 Aug-25 Oct-25 Dec-25 Feb-26 Apr-26 Jun-26

0 Cleveland Fed trimmed mean CPI 2019 average

Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Source: Morgan Stanley Research, Federal Reserve Bank of Cleveland, Bloomberg

8:00a 8:00a 8:00a 8:00a 8:00a

Source: Morgan Stanley Research, Bloomberg