More from Fed’s Musalem, says financial conditions very accommodative, asset prices elevated
Musalem’s warning that conditions are fertile for inflation expectations to become unanchored, paired with his description of financial conditions as very accommodative and asset prices as elevated, signals discomfort with how loosely markets are currently pricing risk relative to his own hawkish reading of inflation. His comment that the Fed can be driven by its mission rather than markets, and that it is sometimes appropriate to surprise investors, raises the prospect of a policy path less dovish than current pricing implies, a mildly negative signal for risk assets and a supportive one for the dollar. His reaffirmation of the dollar’s reserve currency status and confidence in US growth and institutions offers some longer-term reassurance, but the near-term signal remains that elevated asset valuations are on the Fed’s radar as a policy consideration. Risk-sensitive currencies, including the Australian dollar, are likely to stay sensitive to any further hawkish repricing this commentary encourages.
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Earlier:
- Musalem says inflation risks tilted higher, credibility at stake
- More from a hawkish Musalem , says gradual hikes beat abrupt moves as inflation risk builds
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Musalem is drawing a line between anchored inflation expectations today and the fertile ground he sees for them to slip, while making clear the Fed will act on its own mission even if that means surprising markets.
Summary:
- Musalem said the job market seems to be in a good place
- He said he tunes out political noise and stays focused on the Fed’s mission, while watching financial markets very carefully
- Musalem said the Fed needs to do what is best for its mandate but cannot be driven by markets, adding there are times when it is acceptable for the Fed to surprise markets
- He described financial conditions as very accommodative and said a lot of asset prices are elevated, both of which the Fed is watching
- Musalem said the US remains the highest growth and most innovative economy, with effective rule of law, and does not see conditions that would unseat the dollar as the key reserve currency
- He said central banks have been confronted by more supply shocks, and while inflation expectations remain anchored and consistent with 2%, he sees fertile ground for them to become unanchored
- Musalem said he is focused on core inflation amid energy volatility
Federal Reserve Bank of St. Louis President Alberto Musalem said Thursday that while inflation expectations remain anchored and consistent with the Fed’s 2% target, he sees fertile ground for those expectations to become unanchored, the latest in a lengthy set of hawkish remarks delivered across a speech and extended Q&A session. Musalem said the job market seems to be in a good place, an assessment that lets him keep the focus of his remarks squarely on inflation risk rather than a competing concern about employment.
On the Fed’s independence, Musalem said he tunes out political noise and stays focused on the central bank’s mission, while watching financial markets very carefully. He said the Fed needs to do what is best for its mandate but cannot be driven by markets, adding that there are times when it is appropriate for the Fed to surprise them. That comment came alongside a warning that financial conditions are very accommodative and that a lot of asset prices are elevated, both trends he said the Fed is monitoring closely, suggesting he views current market pricing as somewhat detached from the inflation risks he has spent the day laying out.
Musalem struck a confident note on the broader US economy and the dollar’s standing, saying the United States remains the highest growth and most innovative economy, with effective rule of law, and that he does not see conditions that would unseat the dollar as the world’s key reserve currency. He also placed the current inflation challenge in a wider context, saying central banks globally have been confronted by more supply shocks, and said he remains focused on core inflation given ongoing energy price volatility, a nod to the Middle East supply risks that have featured heavily in market commentary this week.
Taken together with his earlier remarks confirming he favoured a rate hike at last week’s FOMC meeting, Musalem’s comments paint a consistent picture of a policymaker who sees inflation risk as underappreciated by markets, financial conditions as too loose for comfort, and the Fed’s credibility as something that must be actively defended rather than assumed.
This article was written by Eamonn Sheridan at investinglive.com.