Fed’s Christopher Waller Talks Higher Yields, Inflation

Christopher Waller · Board of Governors of the Federal Reserve System

AI companies' heavy debt issuance competes for capital and pushes up yields.

Competition from AI-related borrowing is a serious concern for yields. Even if money flows into the US, the funds leaving other countries push up their yields. Waller says the AI build-out is definitely affecting yields. As an example, he notes Google issued a forty-year bond paying 100 basis points over Treasuries, even though it is unlikely to default, which changes how investors view the market.

“the competition from AI is a serious serious concern... you look at Google issued, I think, a forty year bond, and it was paying a 100 basis points over US treasuries.”at 10:03

Christopher Waller · Board of Governors of the Federal Reserve System

Surge in long-term yields is tightening housing and auto demand, doing some of the Fed's work.

When long-term yields rise, borrowing costs in interest-rate-sensitive sectors such as housing and autos go up, which should tighten demand for those products and put downward pressure on prices. Waller says this is a natural spillover from the surge in ten-year and higher yields, not the Fed's intent, and agrees that higher yields are doing some of the work of tighter monetary policy.

“Yeah. Of course it is. Does that tighten off demand for those products and put downward pressure on prices? It should. So it's not our intent to do it, but that's gonna be one of the natural spillovers from this kind of surge in yields at the ten year and higher.”at 13:46

Christopher Waller · Board of Governors of the Federal Reserve System

US Treasuries' safe-haven liquidity premium has disappeared, adding perhaps 50 to 70 basis points to yields.

Investors used to pay more for Treasuries because they were safe, liquid and easy to trade, which kept yields lower. Recent academic research suggests this safety and liquidity premium has disappeared over the last couple of years. If investors no longer see Treasuries as the safest asset to hold, they will not pay that higher price, so yields rise. Waller calls this another reason rates will go up and says the effect is not trivial, possibly 50 to 70 basis points.

“that safety liquidity premium on US treasuries is gone. It's gone... And it's not a trivial sum. It could be like 50 to 70 basis points.”at 14:47

Christopher Waller · Board of Governors of the Federal Reserve System

Fed's overnight rate changes barely move the ten-year yield, which global supply and demand set.

Waller has long argued that the ten-year yield is set by global supply and demand, including Treasury supply. Changing the overnight deposit rate does not drive the ten-year much, and even when it does, the effect lasts only a short time. Therefore, the Fed's policy moves are not the main driver of long-term yields.

“I've long argued that the ten year rate is determined by global supply and demand. What I do, change the overnight interest rate on deposits, that's not driving the ten year yield much.”at 13:18

Christopher Waller · Board of Governors of the Federal Reserve System

Administration pressure on Fed independence has not succeeded; bond market would punish inflationary moves.

Waller sees a threat to Fed independence from the administration, but says it has not succeeded so far because institutions do not want it to happen. He says the bond market is the ultimate protector: if investors fear high inflation, rates would rise sharply, which discourages political interference. He argues that an independent central bank has worked well for forty years in almost all countries that have one, and that moving away from it would be a mistake. He credits Congress and the courts with protecting the institution.

“There is a threat to fed independence by the administration. So far, it hasn't really succeeded... And then the ultimate protector is just the bond market... I just think it's a mistake to even think about going away from it.”at 21:36

Christopher Waller · Board of Governors of the Federal Reserve System

Uneven AI adoption tied to GDP per capita could widen global income gaps.

Waller sees a very high correlation between GDP per capita and AI use in people's work. Because AI use is not spread evenly across the world, productivity differences will follow, which could widen GDP per capita gaps between countries. He notes the US is dominant in building models, Taiwan and South Korea supply key inputs, and Europe is a big user but produces little AI. He stresses he is not a pessimist and does not think AI is a threat to humanity.

“there's a very high correlation between GDP per capita and AI use in people's work... it's not even across the world in terms of how AI is used. And that means it's going to have productivity differences... So you'll see what potentially widening gaps in GDP per capita.”at 2:02

Christopher Waller · Board of Governors of the Federal Reserve System

AI productivity gains take years to show as firms experiment; coding is being transformed now.

Economists know that big technological changes typically take years to show up in productivity, because firms first have to work out how to use the technology. Waller says firms are still experimenting. He points to coding, where AI is already very strong, as an area where jobs will be fundamentally changed but not necessarily lost, as workers can expand output into tasks they could not previously get to. He also notes that measurement is a problem, since AI may save time that goes to leisure rather than output.

“you don't typically see the productivity gains for years. A big part is firms have to figure out what am I using this for? ... I'm telling you, if anybody does any coding, this stuff is amazing.”at 3:32

Christopher Waller · Board of Governors of the Federal Reserve System

AI data center build-out is bidding up chip prices and spilling into US inflation for two to three years.

Several trillion dollars of AI investment by hyperscalers has largely inelastic demand, so buyers bid up the price of semiconductors of all types. That cost pressure spills over to other products, and Waller says this is starting to show in the US. Given how much spending is already committed, he estimates the price pressure could last two to three years. Once the build-out tapers, demand pressure would fall and supply effects would lower prices, but he sees those benefits a few years out. A pullback in the build-out would also ease prices.

“You're gonna bid up the price of all semiconductors of all type, and that's gonna spill over to anybody else who uses those products. And that's what we're starting to see in The US.”at 6:25

Christopher Waller · Board of Governors of the Federal Reserve System

US fiscal situation is weaker than people assume, and investors may demand higher yields.

Waller says fiscal concerns push up yields, citing France as the current example of a government whose finances have lost investor confidence. He says people are starting to realize the US fiscal situation is not that good. If bondholders worry about debt, they will demand a higher yield to buy it. He notes that the US is not yet seeing much of this signal, and that the warning signs would be weak auctions or yields creeping up.

“Could be in The US. People are starting to wake up to our fiscal situation is not that good. And then, naturally, bondholders are going to demand a higher a higher yield to get them to buy that that debt.”at 12:28