Personnel layout, framework reshaping, dovish turn, all point directly to interest rate cuts in the fourth quarter.

Written by: Zhao Ying

Source: Wall Street Journal

The policy framework reform promoted by Federal Reserve Chairman Waller has entered a substantial stage. With the official announcement of the leadership of five working groups on July 9, this internal restructuring, regarded by outsiders as a "united front," is moving forward along a clear three-step roadmap — and its ultimate direction may be a restart of interest rate cut discussions in the fourth quarter.

The leadership list announced by the Federal Reserve overnight features heavyweight figures, including former Bank of England Governor Mervyn King, former Reserve Bank of India Governor Raghuram Rajan, renowned Silicon Valley investor Marc Andreessen, Harvard University economics professor Greg Mankiw, and Nobel laureate Thomas Sargent, covering global central banks, top academia, and the technology industry. The five working groups will focus on assessing monetary policy communication, balance sheets, economic data, productivity and employment, and inflation frameworks, and will submit research reports by the end of the year.

Previously, adjustments to the PCE statistical methodology announced by the Bureau of Economic Analysis (BEA) triggered warnings from institutions like Goldman Sachs and UBS: related changes will systematically lower core PCE inflation readings. Citic Securities published a report before the working group list was announced, linking these trends into a complete policy narrative: personnel layout, framework reshaping, dovish turn, a three-step approach, all aimed at interest rate cuts. The official establishment of the working groups seems to confirm this judgment.

The Five Working Groups Debut, Roster Crosses Central Banks, Academia, and Silicon Valley

According to the Federal Reserve's announcement on July 9, each of the five working groups is co-led by three experts from different fields, supported by Federal Reserve staff.

The monetary policy communication working group is co-led by Mervyn King, Peter Fisher, a professor at the Foster School of Business at the University of Washington and former senior official at the U.S. Treasury, and former Bank of Brazil Governor Arminio Fraga, focusing on how the Federal Reserve can improve policy communication in uncertain environments.

The balance sheet working group is headed by Harvard University economics professor Karen Dynan, Raghuram Rajan, and former Federal Reserve Board member Jeremy Stein. This group will systematically assess the costs and benefits of quantitative easing, quantitative tightening, and the long-term reserves framework.

The economic data working group comprises Harvard University economics professor Raj Chetty, former Walmart CEO Doug McMillon, and University of Chicago economics professor Kevin Murphy, focusing on improving the quality, timeliness, and usability of economic indicators.

The productivity and employment working group, which has the strongest technological flavor in this reform, is led by Marc Andreessen, co-founder of Andreessen Horowitz, Stanford University economics professor Charles Jones, and Microsoft executive vice president Asha Sharma, focusing on assessing the impact of general-purpose technologies like AI on productivity, the job market, and long-term growth potential.

The inflation framework working group is composed of Greg Mankiw, Thomas Sargent, and former economic advisor to the Bank for International Settlements William White. This group will reassess the Federal Reserve's framework for analyzing inflation drivers and developing policy responses.

Waller stated in the announcement that each working group would thoroughly evaluate whether the methods, analytical tools, and policy pathways used by decision-makers can be further improved, with a "very clear goal of ensuring that the Federal Reserve can fulfill its duties in the best possible state during this critical period."

PCE Statistical Method Quietly Adjusted, Goldman Sachs and UBS Warn of Lower Inflation Readings

Before the working group list was published, another clue had quietly emerged.

The BEA announced that it would adjust the methodologies for three components of the PCE price index, which will officially take effect on September 30, 2026, and adjust historical data retrospectively. According to sources from trading desks, Goldman Sachs and UBS released research reports stating that these changes would systematically lower core PCE inflation readings.

Among the three adjustments, the most significant impact comes from the investment management services component. The current method directly uses the PPI nominal expenditure for that industry. Due to rising asset prices pushing up management fees, this component has seen a year-on-year increase of 21.6% in the last 12 months, making it the second-largest contributor to core PCE inflation. The new method will instead use total hours worked from employment surveys to measure "true service volume." Since the growth in hours worked is much slower than the growth in asset size, the calculated price increase will drop significantly. UBS economist Alan Detmeister and others estimate that this change will reduce core PCE year-on-year inflation by about 0.21 percentage points.

In terms of the computer software and accessories component, Goldman Sachs analyst Manuel Abecasis and others estimate that the new methodology will cause core PCE year-on-year inflation to decrease by 0.05 to 0.1 percentage points in May and by 0.1 to 0.2 percentage points in December. The adjustment to the legal services component will cause a slight rise in inflation of about 0.04 percentage points in May, partially offsetting the downward effects of the first two components.

Overall, Goldman Sachs and UBS believe that the net effect is a systematic downward shift in core PCE inflation readings. UBS more directly points out that the method of choosing the adjustments "appears to be aimed at lowering inflation" and warns that the new method lacks transparency, making it difficult for outsiders to independently verify, thus creating a risk of data manipulation.

Citic Securities: Three-Step Roadmap, the Endpoint is Interest Rate Cuts

Citic Securities researcher Qian Wei published a research report before the working group list was announced, interpreting this series of movements as part of a complete policy framework.

The report argues that Waller faces multiple challenges, including weak foundations within the Fed, questions of independence, and disagreements on positions since taking office. His core task is to complete the "united front" for the Fed, which is planned to advance in three steps.

The first step (July): Personnel arrangements. Through the appointment of working group members to the supervisory committee, core policy status is granted to the working group, which will subsequently take on part of the task of guiding market expectations.

The second step (third quarter): Framework adjustments. Traditional employment and inflation indicators are highly volatile in the short term and difficult to reach consensus, providing Waller with an opportunity to introduce a new supply-side framework through the AI revolution. The core logic of the new framework is: rising productivity can control inflation, thereby creating space for monetary easing. Citic Securities cites the 1995 to 1998 case, pointing out that despite high wage growth and strong economic conditions, the trend in labor productivity growth was upward, while inflation fell. The linkage between wages and prices was broken by rising productivity, leading the Federal Reserve to eventually choose to cut interest rates.

The third step (fourth quarter): Position shift. With the groundwork laid in the first two steps, the Federal Reserve turns dovish, and interest rate cut discussions are restarted. Citic Securities notes that currently, labor productivity growth is rising, wage growth is declining, tech industry layoffs are occurring, and the job market is not tight, "essentially a mirror of 1999." If employment and CPI data moderately align, the final conclusions of the working groups will likely aid the Federal Reserve in shifting to a dovish stance, with the interest rate hike discussions retreating.

From the timeline perspective, the establishment of the working groups seems to confirm the internal logic of this narrative — the personnel layout has been completed, while the framework adjustments and the reinterpretation of inflation data are being advanced simultaneously.

The inflation framework working group will reassess the Federal Reserve's methodology for analyzing inflation, the economic data working group will explore ways to improve the quality of indicators, and the productivity and employment working group will provide academic support for the new supply-side framework. Together, these three form a complete closed loop paving the way for interest rate cuts.

Waller stated that the U.S. economy has "undergone tremendous changes over the past generation, and the pace of change is unprecedented," making it necessary for the Federal Reserve to reassess its policy tools and analytical methods. Each working group will submit research reports by the end of the year, at which point the contours of the policy framework adjustments will become clearer.