MNI: Fed's Musalem - Could Be 'Quarters' Before First Rate Cut

St. Louis Fed President Alberto Musalem in his first public remarks Tuesday questioned the degree of restrictiveness of the current stance of monetary policy and said it "could take months, and more likely quarters" before he's confident that a reduction in interest rates is appropriate.

"The current policy posture balances the risk of easing policy too early with the risk of easing policy too late," he said in prepared remarks, adding that monetary policy "is continuing to exert downward pressure on aggregate demand and inflation."

"I will need to observe a period of favorable inflation, moderating demand and expanding supply before becoming confident that a reduction in the target range for the federal funds rate is appropriate. These conditions could take months, and more likely quarters to play out," he said.

Musalem said measures of monetary policy restrictiveness depend on views for underlying inflation and the long-run neutral rate of interest. "Policy appears less restrictive if the underlying rate of inflation is higher, say the 3.5% year-to-date PCE inflation rate that forecasters expect through May, or if the long-run neutral rate of interest is thought to be higher."

"I believe the long-run neutral rate is higher than 0.5%," he said. "Financial conditions feel accommodative for some parts of the economy while restrictive for others." (See: MNI INTERVIEW: Good Chance Fed Won't Cut Rates In 2024-Plosser)

ALTERNATIVE SCENARIOS

The new St. Louis Fed chief said he is attentive to alternative scenarios where inflation becomes stuck meaningfully above 2% or moves higher, in which case he would support an additional firming of monetary policy. But so far inflation “getting stuck” or “rising” are not the most likely scenarios, he said.

Instead, there are "potential early signs of continued progress on inflation" and the St. Louis Fed is hearing reports from contacts about price cuts and discounting because consumers are becoming more price sensitive, he said.

The PCE price index should should show a welcome downshift of inflation in May and Musalem is hopeful this could mark a resumption of progress toward 2% inflation, he said. "However, it takes more than one data point to establish a trend."

The labor market remains tight and has continued to rebalance, while aggregate consumption looks set "to moderate in coming quarters, without stalling, and then return to or slightly exceed trend by 2026."

"As reported this morning, May retail sales were weaker than expected, suggesting that aggregate demand is growing at a moderate pace thus far this quarter."