Musalem from the Federal Reserve has indicated that he may support rate hikes due to concerns over tariff-related price increases. He cautioned against assuming these price hikes will be temporary and suggested that second-round effects might lead to more persistent inflation.
He stated that if the labour market remains strong and inflation expectations rise, a modestly restrictive policy could be necessary for a longer period. Currently, the market anticipates 82 basis points of easing within the next 16 months, contingent upon developments post-April 2 regarding tariffs.
Rising Price Trends
Recent surveys reveal an increasing number of firms planning to raise prices, contrasting with late 2024 results. However, Musalem also noted the possibility of rate cuts if unemployment rises, indicating a range of potential scenarios.
Musalem’s remarks highlight the possibility of interest rate adjustments depending on how economic conditions develop. His warning about second-round effects suggests that price increases linked to tariffs could embed themselves in the broader economy, making inflation more stubborn. If businesses pass higher costs on to consumers, expectations for future price rises might shift, necessitating a different monetary approach.
The reference to a strong labour market shows why policymakers remain cautious. If employment levels stay high and wages continue increasing, there is a risk that inflation will not ease as quickly as markets currently anticipate. Under such conditions, maintaining borrowing costs at a slightly restrictive level for an extended period might be necessary. Current pricing in futures markets suggests traders expect cuts in the months ahead, but this view rests heavily on economic data yet to be seen.
Surveys now indicate a growing number of businesses are looking to increase prices, which contrasts with responses collected towards the end of last year. This change adds another layer to inflation forecasts, suggesting cost pressures may not fade as quickly as previously thought. While some companies might be responding to tariff-related expenses, others could take advantage of broader conditions to adjust their pricing strategies.
Policy Implications
Musalem acknowledged that policy could shift in the opposite direction if labour market conditions weaken. A rise in unemployment would alter expectations, possibly prompting a different response from policymakers. This creates multiple potential paths for interest rates, keeping markets highly sensitive to incoming reports. For those assessing risk in the coming weeks, understanding the balance between inflation persistence and employment trends will be key.
