Musalem says Fed probably needs more rate hikes as inflation risks persist

Just days after the Fed's latest rate increase, Musalem's remarks underline the hawkish stance in the central bank. His choice to move early rather than wait matches what markets already anticipate: investors see three additional quarter-point hikes over the next five meetings, ending in April, along with about even odds of an October rise. By describing the existing 3.75-4.00% policy rate as still "on the accommodative side," he indicates that there is considerable room for additional moves before policy turns restrictive. On commodities, his naming of copper and other base metals, along with oil, widens the inflation story beyond the Middle East energy shock that has featured prominently in recent Fed discussion. That could also draw more market focus on industrial metals prices as an input relevant to policy, just as crude is.

Greg broke the story:

• St. Louis Fed’s Musalem: Interest rates likely need to rise further to tame inflation

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• Fed's Collins pencils in second hike this year, then expects rates on hold in 2027

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• Deutsche Bank says markets underpricing scale of global rate hiking cycle

Musalem contends that the Fed's rate increase this month may prove insufficient, arguing that delaying further action would be more harmful than applying modest hikes quickly.

Summary:

• Musalem, who leads the St. Louis Fed, told Reuters on Monday that absent additional policy restraint, inflation is more likely to remain well above the central bank's 2% objective 18 months out than to hit it.
• He pointed to persistent demand and recurring supply-side pressures as reasons inflation risks remain high, and said further rate increases are likely needed to tackle both.
• The current 3.75%-4.00% policy rate, in Musalem's view, remains "on the accommodative side," implying it is still boosting rather than holding back economic activity.
• He also said the labour market is steady near full employment and is not now adding to inflation pressures.
• The latest commodity shock, according to Musalem, covers not just oil but also base metals like copper; even with supply-related factors stripped out, inflation sits at as much as 3% and is "too high."
• Business contacts, he said, are planning price rises nearer to 3%, and a Fed that moves "earlier and incremental" would be preferable to one that goes "later and larger."

Alberto Musalem, president of the Federal Reserve Bank of St. Louis, said Monday that the central bank will probably have to push interest rates higher still to control inflation. He warned that without further policy restraint, prices would more likely remain well above the Fed's 2% target 18 months from now than converge on it, according to Reuters.

In an interview, he said persistent demand, together with recurrent supply shocks, is keeping inflation risks high, and that strong policy restraint is essential for the Fed to hit its objective in about 18 months.

Musalem referred to the Fed's current 3.75%-4.00% policy rate as "on the accommodative side" following the quarter-point increase this month, indicating the stance may still be stimulating the economy instead of braking it. He said household spending and business investment are expanding at what he termed a healthy, strong pace, even as inflation risks have grown for multiple reasons, geopolitical ones among them. On employment, he said the labour market remains steady near full employment and is not now feeding inflation pressure, a contrast with a wage-push inflation scenario.

Turning to what is driving prices, Musalem widened the commodity shock from oil alone to include base metals such as copper. Even if all supply-related factors are set aside, he said, underlying inflation remains "too high," at as much as 3%, and business contacts have told him they are planning price rises near that figure. He said companies are flagging substantially higher non-wage input costs in areas such as fuel, other raw materials, transportation, insurance and skilled labor, and that ample evidence shows inflation is now the main challenge for the economy.

Regarding the timing of additional tightening, Musalem said he prefers increasing rates "earlier and incremental" over holding off for "later and larger" moves, since quicker, smaller steps would probably cause less economic disturbance than a delayed response. His comments come after the Fed voted unanimously last week to lift its benchmark rate by a quarter point, the first rise in over three years, which Chair Kevin Warsh characterized as withdrawing a degree of policy accommodation. Markets now price in three more quarter-point hikes over the five Fed meetings from now through April, with approximately even odds on an additional increase in October, shortly before the US midterm elections.