MNI: Musalem Warns Easy Fed Policy 'Unadvisable'

Further U.S. interest rate cuts would bring monetary policy to an "unnecessary and unadvisable" accommodative stance given strong consumer demand, rising non-labor costs and the impact of tariffs and energy prices, Federal Reserve Bank of St. Louis President Alberto Musalem told MNI on Tuesday.  

"I see little reason for near-term further easing of policy," he told an MNI Connect webcast. "Given the risk that inflation could still be persistent, I think that it's unnecessary and unadvisable to bring monetary policy into an accommodative stance at this point in time." 

The softer-than-expected December CPI report Tuesday comes in line with Musalem's judgment that the risk of inlation accelerating from here has moderated, but he remains concern that inflation could be stickier than desired. 

"We have a very robust economy with a very robust consumer, with very strong demand, with rising electricity and other energy prices. Therefore we have to watch the balance of risks," he said. 

INFLATION RISK MODERATES

After 175 bps of cuts over the past 16 months, the Fed's target policy rate has fallen to 3.5%-3.75%, "right around neutral," Musalem said. 

"Policy is really well positioned right now, balancing both the expected path of the economy and the risks on both sides," he said, adding he estimates the real neutral rate at roughly 1%-1.2%. 

"If the labor market risks were to rise more than I currently expect, or if the risk that expected inflation begins to undershoot 2% on a persistent basis, of course at that point it might be appropriate to reduce the policy rate further. But I would have to see those risks materialize."

Inflation is still closer to 3% and than the Fed's 2% target but will cool this year as housing inflation slows and tariff effects fade in the second half of the year, Musalem said. 

That the U.S. might have entered a higher productivity regime offers additional hope that the economy can experience higher growth with lower inflation and lower interest rates, but increased demand for capital to invest in AI and other technologies pushes rates in the other direction, Musalem said. 

"It's too early to call that, and it's certainly too early to outsource our job of bringing inflation back towards 2% to assumptions about productivity." (See: MNI POLICY: Fed Warms To Productivity Step-Up, Rethinks Risks)

RESILIENT LABOR MARKET

The labor market has been cooling in an orderly way over the past nine months or so, Musalem said, and growing downside risks had convinced him to vote for last year's rate cuts. 

Demand for labor has been slowing due to policy uncertainty and a "hiring overhang" after the Covid-19 pandemic, when labor markets were very robust, Musalem said. But supply has shrunk in tandem with demand, with immigration flows down materially and demographic developments pulling down participation rates.

The unemployment rate at 4.4% in December sits right around the neutral rate of unemployment, with hiring near the current breakeven rate of 30,000-80,000 jobs a month, he said. Business surveys have been robust, initial claims for jobless benefits have been stable to falling, and layoff announcements have come back down, he said. 

"We're kind of still near full employment and not falling off of a cliff when it comes to the job market," he said. "If you add on to that the growth backdrop, I would think that that would lead a policymaker to find some comfort in the in the likely future resilience of the labor market." (See: MNI INTERVIEW: Fed Could Cut Around 100BP This Year-Bell)