Fed should ‘tread with caution’ on rate cuts, Musalem says

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By Ann Saphir

(Reuters) -St. Louis Federal Reserve President Alberto Musalem on Friday said he sees possible room for one more interest rate cut to shore up the labor market, but urged caution because inflation remains “materially” above the U.S. central bank’s 2% target.

“I am open-minded about a potential further reduction in interest rates to provide further insurance against labor market weakening,” Musalem said at the Springfield Area Chamber of Commerce in Missouri.

But, he added, “I believe that we have to tread with caution because there’s limited room for further easing before monetary policy could become overly accommodative, and I believe that monetary policy should continue to lean against persistence in inflation.”

Trading in interest-rate futures contracts reflects heavy bets that the Fed will follow its quarter-percentage-point rate cut last month with same-sized reductions at its October 28-29 and December 9-10 meetings.

And while some Fed policymakers, including the influential New York Fed chief John Williams, have leaned into that expectation, Musalem’s comments suggest he may not be sold on the idea. Kansas City Fed President Jeff Schmid, another of the Fed’s 12 voting rate-setters this year, likewise has emphasized inflation concerns.

Both had joined the 11-1 majority at the Fed approving the Fed’s quarter-percentage-point rate cut last month.

Musalem on Thursday said he expects U.S. economic growth to be healthy in the fourth quarter and to run at or a bit above its long-run potential next year, bolstered by robust consumer spending thanks in part to lower interest rates.

But, he said, some groups like Hispanics are slowing their spending, and lower- and middle-income households are only maintaining their spending through borrowing.

“Their real incomes, their wages adjusted for inflation, haven’t been growing at a rate that allows them to consume comfortably without taking on additional credit,” he said, attributing the insight to a recent conversation with community development practitioners. “That drove home for me that it’s really important for us to achieve our 2% price stability or inflation goal to support consumption.”

He said he feels the Trump administration’s tariffs are only responsible for about 10% of the current rate of inflation, and that he expects their effect to dissipate by the middle of 2026, allowing inflation to head back to the Fed’s 2% target. Musalem expects the labor market “to continue to soften some going forward in an orderly way, with the supply and demand both muted.”

But that’s only a baseline, he said, and there are risks that inflation could be more persistent, or that the labor market could weaken more than expected – one reason that he does not rule out some more “insurance” in the form of another reduction in borrowing costs.

Still, he said, the Fed should be careful, especially in light of the stock market rally in recent months.

“I now perceive monetary policy as somewhere between modestly restrictive and neutral, and I see, when I look out the window, financial conditions and financing conditions which are very accommodative of the growing economy,” he said.

(Reporting by Ann Saphir; Editing by Chris Reese, Paul Simao and Deepa Babington)