Fed Official Calls for Resumption of Gradual Rate Cuts

St.Louis Federal Reserve President Alberto Musalem is concerned that easier financial conditions may stimulate demand and undermine efforts to combat inflation.A senior Federal Reserve official has said that after the unusual large interest rate cut of 50 basis points earlier this month,the Federal Reserve should return to a "gradual" approach to interest rate reductions.

Alberto Musalem,President of the St.Louis Federal Reserve,stated that the U.S.economy could respond "very strongly" to easier financial conditions,thereby stimulating demand and extending the time it takes to achieve its 2% inflation target.

Musalem told the Financial Times last Friday,"For me,the rate cut is about taking the foot off the brake for the economy at this stage,allowing policy to gradually become less restrictive."

In the forecasts released earlier this month,he was one of the officials who expected the Federal Reserve to cut interest rates several times this year.Musalem became the President of the St.Louis Federal Reserve in April and will become a voting member of the Federal Open Market Committee (FOMC) next year.

Less than two weeks ago,the Federal Reserve abandoned the more traditional interest rate cut of 25 basis points,initiating the first easing cycle since the outbreak of the COVID-19 pandemic in early 2020 with a 50 basis point cut.This substantial rate cut kept the federal funds rate between 4.75% and 5%.Federal Reserve Chairman Powell said that the move was aimed at maintaining the strength of the world's largest economy and avoiding a weak labor market as inflation subsides.

Last Friday,the Federal Reserve's preferred inflation indicator—the August PCE annual rate—fell to 2.2%,a drop that exceeded expectations.After the data was released,interest rate futures traders believed that the possibility of a 50 basis point interest rate cut by the Federal Reserve in November was slightly higher than that of a 25 basis point cut.

Musalem supported a substantial interest rate cut in September,acknowledging that the labor market has cooled in recent months,but he remains optimistic about the outlook given the low rate of layoffs and the underlying strength of the economy.He said that the business sector is in a "good condition," and business activity is generally "stable," adding that large-scale layoffs do not seem "imminent."

Nevertheless,he acknowledged that the Federal Reserve faces risks that could prompt it to cut interest rates more quickly.He said,"I realize that the economy could be weaker than I currently anticipate,and the labor market could be as well.If that's the case,then it might be appropriate to accelerate the pace of rate cuts."

This echoes the comments made by Federal Reserve Governor Waller last week,who said he would be "more willing to cut rates aggressively" if the data weakens more quickly.Musalem said that the risks of economic weakness or growth that is too rapid have now balanced,and the next interest rate decision will depend on the data at the time.The Federal Reserve's latest "dot plot" indicates that most officials anticipate the policy interest rate will be reduced by an additional 50 basis points during the two remaining meetings this year.The next meeting is scheduled for November 6th,the day after the U.S.presidential election.

However,opinions among officials vary,with two suggesting that the Fed should postpone further rate cuts,while another seven predict that there will only be an additional 25 basis point reduction this year.Policymakers also expect the policy interest rate to decrease by another 100 basis points by 2025,ranging between 3.25% and 3.5% by the end of the year,and slightly below 3% by the end of 2026.

In response to the claim that the Fed was "playing catch-up" with a 50 basis point rate cut in September due to being too slow in easing monetary policy,Musallam refuted this,stating that inflation has been falling much faster than he anticipated.

He said,"The (significant rate cut) sends a strong and clear message to the economy that we are starting from a very favorable position,and that is appropriate."