Feds Waller: Finally seeing some signs of disinflation in recent data. How are the markets reacting?

Fed's Waller is speaking and although he is keeping the door open for a tightening is also encouraged by signs of disinflation.  Waller says:Open to leaving rates unchanged at the September meeting if inflation cools. Finally seeing some signs of disinflation in recent data. Communicating his reaction function helps the public plan. Would consider a September rate hike if August inflation data comes in hot. Inclined to support holding rates steady at the September 15–16 meeting if August inflation data shows continued progress. It may not take much acceleration in inflation to support tighter policy. If August inflation data shows progress has reversed, a “small adjustment” to the policy rate would help ensure progress resumes. GDP is growing at a solid pace, while equity price gains should sustain consumption growth. Considerable uncertainty surrounds the outlook for prices and the economy because of military conflicts, trade policy and AI. Inflation remains significantly above the Fed’s 2% target. AI investment is a legitimate part of GDP, and AI will reliably raise productivity. Elevated energy prices and tariffs are not significant sources of ongoing inflation pressure. Underlying inflation is doing better than the core numbers suggest. The labor market is in satisfactory shape; expects more of the same in the August jobs report. Sees some upside inflation risk, though wage growth is consistent with inflation returning to 2%. Core PCE is not the best guide to where inflation stands. Sees considerable improvement, with an encouraging pace of progress in three-month core inflation. Pending revisions to the Commerce Department’s non-market price estimate could lower 12-month PCE inflation by a few tenths of a percentage point.Says that we should start seeing some lower numbers on inflation. He expects a reasonable CPI When you are near a turning point you have to put more weight on near-term data.Waller is keeping his options open ahead of the September meeting, with the August inflation data likely to decide which way he leans. If inflation continues to show progress, he would support keeping rates unchanged. However, if the data comes in hot, a rate hike is on the table—and he warns it may not take much acceleration in inflation to justify tighter policy.The good news is that Waller sees underlying inflation doing better than the headline core numbers suggest. The concern is that inflation remains well above the Fed’s 2% target, while growth and the labor market remain solid. Putting it another way, Waller is comfortable waiting if inflation cooperates, but prepared to hike if it does not. Rate cuts are not the message from these comments.The US yields are pushing to the downside with the 10 year down -320 basis points at 4.756%. The 2 year yield is down 5.4 basis points at 4.331%.US stock prices are also ticking to the upside (but modestly) with the Dow up 223 points in premarket trading. The S&P is p 8.4 points. The Nasdaq is still modestly lower by -12 points.  The Federal Reserve will announce its interest rate decision on September 16. The US PPI data will be released on September 10 next week while the US CPI data will be released on September 11. From that data, economic models will forecast the PCE data which is the more favored measure of inflation by the Fed. However the official PCE data will not be released until later this month - after the FOMC rate decision.The market is now pricing in a 60% chance of a rate hike. That is still down from about 67% yesterday but certainly well up from the 30% numbers that we were seeing a week or so ago.More comments: Willing to sit, wait and be patient. If inflation progress reverses in August, willing to pull the trigger on a rate hike. Open to leaving rates unchanged this month if inflation cools. “I’ll let you define what ‘hot’ is.” Does not want to put a number on it, but if the three-month inflation number gets to 2.8%, “that’s fine.”Might see a significant drop in core inflation with revisions.Give disinflation a chance; we can wait one meeting.Not going to say wait until next year, but let's wait to see improvement on inflation. There is little cost to waiting one meeting. This is risk management. Not taking big chances. Maybe non-market prices should be pushed aside. If potential capacity is increasing, increased output is not inflationary. Could see disinflation from AI; potential is rising. AI is an amazing technology.AI hasn't shown up in data yetSays that mortgage rates auto loans are not lowOn the US deficit says the US cannot keep running a 3% structural deficitYields are going up because of fiscal stuff also AI competition for capitalWhy does that matter? The 2-year Treasury yield is particularly sensitive to expectations for Fed policy. With traders pricing in a slightly lower chance of tightening, that yield is down 5.4 basis points to 4.331%. The 10-year yield is also lower, down 3.2 basis points to 4.756%. Lower yields can help support stocks by reducing borrowing costs and making future earnings more attractive. They can also weigh on the USD if the interest rate advantage of holding dollars narrows.Putting it another way, a Fed speaker can leave the door open to a hike and still give markets some relief. What matters is where expectations were before the comments and how they change afterward. Today’s decline in yields and modest improvement in stock futures are consistent with traders focusing on Waller’s encouragement over inflation. That does not mean he is signaling a rate cut.The next inflation reports become especially important because Waller is telling traders what would influence his vote. Softer numbers would strengthen the case for holding steady. Hotter numbers would push the discussion back toward a hike. His comment about putting more weight on near-term data increases the importance of those upcoming releases.For traders, the fundamental news provides the catalyst, but the price action and technical levels help tell us whether the market is following through. If lower yields weigh on the USD, look for dollar selling to take the currency pairs through key moving averages and swing areas—and stay through those levels. If the breaks fail, the sellers may have had their shot. The headlines can shift expectations. The technical levels help define the bias and the risk.The NASDAQ index is now up around 45 points as market traders start to react more favorably to the comments from Fed's Waller. This article was written by Greg Michalowski at investinglive.com.