Fed’s Musalem warns Fed nearing limits on rate cuts

Federal Reserve Bank of St. Louis President Alberto Musalem has argued that there’s limited room for more rate cuts despite increased inflation. He acknowledged that he championed last week’s 25-bps rate cut to take out insurance against a weakening labor market.

The American economist maintained that interest rates are currently between modestly restrictive and neutral. He revealed that he would support further rate cuts if the labor market continues to worsen. Musalem also believes that it’s important to keep long-term interest rates stable.

Musalem expects more cuts if the labor market worsens

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The banker stated that he supported the FOMC’s quarter-point rate cut last week as a precautionary move intended to support the labor market at full employment and against further weakening. He added that the little room left for further easing will ensure policy won’t become overly accommodative.

The president of St. Louis Bank argued that recent economic data shows that the adverse risk to employment was surging. He added that he still expects risk inflation to remain above the central bank’s 2% target. 

According to Fed’s Musalem, booming stock markets and low credit spreads continue to support the economy. He urged policymakers to tread carefully because rates are close to neutral after adjusting for inflation, which is a level that neither boosts nor slows growth. 

“Should further signs of labor market weakness emerge, I would support additional reductions in the policy rate, provided the risk of above-target inflation persistence has not increased and long-term inflation expectations remain anchored.”

-Alberto Musalem, President at the Federal Reserve Bank of St. Louis.

The economist noted that the impact of tariffs on prices has so far been less than expected. He also warned that other factors seem to be contributing to above-target inflation. Musalem believes that monetary policy is continuing to lean against persistence in above-target inflation, regardless of whether it gains from the impact of levies, lower supply growth, or other reasons.

The St. Louis bank president also maintained that he expects the effects of tariffs on prices to fade in the next two to three quarters. He also urged policymakers to stay on guard against second-round effects and the threat of persistent inflation. The banker added that he was approaching policy moves on a meeting-by-meeting basis as he votes on rate decisions this year.

Atlanta Fed President Raphael Bostic also mentioned that he was comfortable with last week’s rate cut but sees little need for further cuts this year. The banker revealed that he expected only one rate cut in 2025 in his economic projections, which were in line with what he predicted in June.

Bostic said he’s concerned about inflation, which has remained high for a long time. The banker will not be voting on policy until 2027, but highlighted that he would not be moving or in favor of it.

The FOMC indicated in its closely watched dot plot that one official wanted no cuts this year, including last week’s. According to the data, eight policymakers were content with just one more cut this year. The FOMC also revealed that a few officials expect two more cuts, suggesting one cut each at the two remaining meetings this year.

Rate cuts cause a decline in bond prices 

After the Fed cut rates last Wednesday, longer-term Treasury yields surged last week, a sign that bond investors didn’t get the assurances they sought. The rate cut also saw investors sending stocks to record highs as they championed the first rate cut of the year. 

Chief investment officer at One Point BFG Wealth Partners, Peter Boockvar, noted a selloff in the bond market. He acknowledged that long-term bond traders didn’t want the Fed to cut interest rates. He also explained that prices and yields for bonds move in an inverse direction; that’s why long-term bond sales drove down the price and drove up the yield.

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