The Fed’s Musalem is a hawk so it’s not shocking that he is mentioning rate hikes but it’s the first utterance of the H-word in the current cycle.
He said that he is wary of assuming all tariff-related price increases will be temporary as second-round effects could be more-persistent. If second round effects become apparent then the Fed may need to keep rates higher for longer or consider more-restrictive policy.
“If the labor market remains resilient and the second-round effects from
tariffs become evident, or if medium- to longer-term inflation
expectations begin to increase actual inflation or its persistence, then
modestly restrictive policy will be appropriate for longer or a more
restrictive policy may need to be considered,” Musalem said.
The market is still pricing in 82 basis points in easing over the next 16 months including two cuts by the end of October but that will depend on what begins to unfold after April 2, which is Trump’s tariff deadline.
In addition, he also noted that several recent surveys indicate that more firms have or are planning to
raise prices in coming months compared with surveys from the fourth
quarter of 2024.
All said, he balances out much of the hawkish rhetoric with the other side, saying they could cut rates even with tariffs if unemployment climbs. It’s really a walk through a number of scenarios but the nod to higher rates isn’t an accident.
Quotable:
I would be wary of assuming that the impact of tariff increases
on inflation will be entirely temporary, or that a full “look-through”
strategy will necessarily be appropriate. I would be especially vigilant
about indirect, second-round effects on inflation. I would also be
uncomfortable if medium- to longer-term inflation expectations begin to
rise. With inflation already above 2% in a full-employment economy, the
stakes are potentially higher than they would be if inflation were at or
below target, and if consumers and businesses had not recently
experienced high inflation, raising their sensitivity to it.
This article was written by Adam Button at www.forexlive.com.
