Musalem from the Fed: Room for Rate Cuts Is Narrowing

St. Louis Federal Reserve Bank President Alberto Musalem warned that despite elevated inflation, the Fed has limited scope for further easing of monetary policy. He recalled that last week he supported a 25-basis-point cut to prevent additional weakening in the labor market, but stressed that future moves should be made with maximum caution. Musalem noted that interest rates currently sit between slightly restrictive and neutral levels. If labor market conditions continue to deteriorate, he would support another rate cut, but only if the risk of persistently high inflation does not increase. “If further signs of labor market weakness appear, I would support a cut in the federal funds rate — but only if inflation expectations remain anchored,” he emphasized. According to him, the economy is currently supported by strong equity markets and low credit spreads. However, he added that the Fed is approaching a neutral real rate, which neither stimulates nor slows growth.

Risks of persistent inflation Musalem pointed out that the impact of tariffs on consumer prices has so far been smaller than expected, but above-average inflation is being fueled by other factors. He argued that monetary policy continues to lean toward inflation staying above the Fed’s 2% target, regardless of whether this is due to tariffs, supply-side challenges, or other reasons. Still, he expects the tariff impact to fade over the next two to three quarters. The banker also highlighted the need to watch out for secondary effects and warned of the threat of persistent inflation. He stressed that each policy decision must be taken on a meeting-by-meeting basis, as the outlook can shift quickly.

Divided views within the Fed In contrast to Musalem, Atlanta Fed President Raphael Bostic said he was satisfied with last week’s rate cut but saw no need for further reductions this year. Based on his June forecast, he expects only one rate cut in 2025. Bostic also voiced concerns about long-lasting high inflation. While he will not vote on policy until 2027, he emphasized that he would not support additional easing. The Fed’s latest dot plot revealed that one policymaker opposed even last week’s cut, while eight others foresee just one rate reduction this year. Several officials project two cuts, each spread across the remaining meetings of the year.

Market reaction Financial markets responded with mixed signals. Yields on long-term Treasuries spiked, as bond investors did not find enough reassurance in the Fed’s actions. Equities, however, soared to record highs, with investors welcoming the first rate cut of the year as a supportive move for the economy. Peter Boockvar, Chief Investment Officer at One Point BFG Wealth Partners, noted the sell-off in the bond market. He explained that long-term bond traders are not eager for the Fed to lower rates. Since bond prices and yields move in opposite directions, heavy selling pushed prices down and yields higher, signaling skepticism toward further rate cuts.

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