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A senior Federal Reserve official has assessed the likelihood of Donald Trump’s trade war causing a sustained increase in inflation at “50-50”, cautioning that US rate-setters will face uncertainty “throughout the summer”.
St Louis Fed president Alberto Musalem told the Financial Times that while Trump’s tariffs could temporarily raise inflation for “a quarter or two”, there is an equal chance that the impact on prices could be more long-lasting.
The Trump administration has escalated US tariffs on its trading partners to levels not seen in nearly a century, potentially leading to higher inflation and slower economic growth. This has prompted policymakers to take a cautious approach after reducing interest rates by 1 percentage point in the latter half of last year.
Recent weeks have seen turmoil in bond markets due to Trump’s substantial budget proposal, which the Congressional Budget Office estimates will add $2.4 trillion to the national debt over the next ten years. While the bill has passed the House, it is still under debate in the Senate.
Musalem, who has a vote on the Federal Open Market Committee, suggested that a positive outcome where trade and fiscal policy uncertainties are resolved by July could pave the way for rate cuts in September. However, he also raised concerns about the possibility of rising inflation with uncertain persistence.
He stated, “right now, it’s probably a 50-50 assessment” of either scenario unfolding.
Economists believe that the Fed’s hesitance to cut rates stems from expectations that tariffs will drive up US prices in the coming months, potentially pushing headline PCE inflation well beyond the 2 per cent goal.
Surveys indicate that consumers and businesses anticipate higher inflation as tariffs take effect, raising worries among Fed officials about public confidence in the central bank’s ability to control inflation.
The Fed is navigating these challenges amidst political pressure from President Trump, who has criticized chair Jay Powell for not lowering rates and called for a significant rate cut.
Musalem emphasized the importance of the Fed’s independence in the face of political interference, noting that it allows for “more anchored inflation expectations”.
Keeping inflation expectations stable is crucial for Fed officials like Musalem, who see it as a prerequisite for rate cuts.
As the Fed heads into its mid-June policy meeting, where rates are expected to remain unchanged, Musalem does not anticipate significant revisions to economic projections compared to March. He highlighted the ongoing economic uncertainties following Trump’s tariff announcement in April.
He stated, “I think we still have some uncertainty. Through the summer, we need to understand what the trade negotiations may be, what legal challenges there may be, or how that resolves in terms of the tariffs. I’m also focusing on fiscal policy and what the shape of that is going to be along with immigration policy and regulatory policy.”
Musalem, with a background in finance before joining the Fed, acknowledged the market’s response to recent events, stating, “There are days when markets send you a very clear message and that was one of those days.”
Investors reacted to Trump’s policies by selling US assets and 10-year Treasury bonds, reflecting concerns about the US’s safe-haven status. Asset managers are considering rebalancing their portfolios, moving away from an overweight position in US assets towards other countries.