Musalem: Cautious Approach to Further Rate Cuts Amid Inflation Concerns

Musalem's Cautious Stance on Interest Rates

St. Louis Federal Reserve President Musalem reiterated his support on Monday for last week's interest rate cut, but cautioned that there is limited room for further monetary easing. This comes less than a week after the Federal Open Market Committee (FOMC) lowered the benchmark interest rate by 25 basis points. Speaking at the Brookings Institution in Washington, Musalem stated that last week's rate cut was a "precautionary move to support full employment and prevent further weakening in the labor market." As a voting member of the Federal Open Market Committee (FOMC) in 2025, he believes that the current federal funds rate (4.00%-4.25%) is close to neutral, and further cuts could undermine anti-inflation efforts.

Inflation and Labor Market Risks

Musalem noted that recent data indicates that downside risks to employment have risen, but added that he still believes inflation may remain above the Fed's 2% target. This means that policy rates need to remain at a high enough level to offset the risk of rising prices. He added that tariffs are exacerbating inflation, and although the impact has been less than expected, the full effect may take several months to materialize as companies adjust prices. "Monetary policy should continue to lean against inflation persistently running above target," Musalem said. While unemployment may present risks, unless those risks start to materialize, "over-emphasizing the labor market…may do more harm than good."

Consumer Spending and Economic Growth

At the same time, he pointed out that consumers are still spending, economic growth is slowing but still near trend levels, and thriving stock markets and lower credit spreads continue to support the economy. In this context, Musalem said that policymakers should proceed cautiously because current inflation-adjusted interest rates are close to neutral – a level that neither promotes nor reduces growth. Musalem concluded that "If further signs of labor market weakness emerge, I would support further rate cuts, provided that the risk of inflation persistently running above target does not increase and that long-term inflation expectations remain stable."

Tariffs Impact on Inflation

Research from the St. Louis Fed shows that 2025 tariffs have already pushed core PCE inflation up by about 0.3%, and this impact could widen if companies pass more costs on to consumers. The FOMC, responsible for setting interest rates, lowered borrowing costs last week, the first time since 2025, but forecasts released after the meeting showed differing views among policymakers on the path of future cuts in the coming months. Seven policymakers expect no further rate cuts this year, 10 expect at least another 50 basis points of cuts by December; and two expect another 25 basis point cut. Musalem's statement may exacerbate the market split over the policy path. Currently, federal fund futures show that traders are still betting on 25 basis point cuts in October and December, but opposition from hawks like Musalem and Bostic could limit the size of actual cuts.