Fed’s Musalem flags threat of rising inflation expectations and stagflation

By Howard Schneider

WASHINGTON (Reuters) – St. Louis Fed President Alberto Musalem on Thursday raised the dual dangers of rising inflation expectations and difficult-to-address stagflation, in remarks that highlighted the doubtless tough decisions going through the U.S. central financial institution.

Whereas a lot of his colleagues say they regard inflation expectations as anchored, Musalem stated he was involved latest information confirmed they might be rising – a growth which may power the Fed onto a extra restrictive path.

“Within the present surroundings, the stakes are increased than they’d be if inflation was at or beneath goal,” Musalem stated in feedback ready for supply to the Financial Membership of New York. “The danger that inflation expectations may change into unanchored is increased than it might be if the economic system was working with slack and if shoppers and companies had not not too long ago skilled a interval of excessive inflation.”

Whereas he stated he nonetheless feels inflation will converge to the Fed’s 2% goal, “market and a few survey measures point out that near-term expectations of inflation have risen notably over the previous three months,” Musalem stated. If inflation does get caught at present above-target ranges or expectations do rise, “a extra restrictive path of financial coverage relative to the baseline path is perhaps acceptable.”

Musalem’s remarks didn’t give his present view about rate-cut expectations for this yr.

However his warnings spoke to the potential problems surrounding the Fed’s foremost narrative of falling inflation and eventual additional price cuts, an outlook that has remained the baseline at the same time as officers acknowledge the potential influence on costs of recent Trump administration import taxes and immigration guidelines.

That is still Musalem’s core outlook as properly, with financial coverage remaining restrictive “till inflation convergence is assured.”

However coming coverage shifts “may materially have an effect on the trail of the economic system,” he stated. “The dangers of inflation stalling above 2% or shifting increased appear skewed to the upside … An alternate and believable state of affairs through which inflation ceases to converge, or rises, on the identical time the labor market weakens should even be thought of.”

The mix of slowing development and excessive inflation is a worst-case state of affairs for central bankers, leaving the Fed with stress between its employment and inflation targets and compelled to decide on which one to prioritize.

(Reporting by Howard Schneider; Enhancing by Paul Simao)