Musalem: Inflation fight likely requires more rate increases

St. Louis Fed's Musalem commented as follows:

• If no further policy restraint is applied, the odds rise that inflation will remain well above the 2% target 18 months from now.
• To bring down price pressures that are coming from both demand and supply, interest rates probably need to rise further.
• The labor market is steady at around full employment and is not generating inflation pressure.
• The commodity shock goes beyond oil, with base metals such as copper also involved.
• Rate increases are preferable when they are “earlier and incremental” rather than “later and larger.”
• After supply-related influences are set aside, inflation is still “too high,” running at up to 3%.
• Business contacts report that they intend to raise prices “closer to 3%.”

Analysis: A distinctly hawkish message comes through in Musalem's comments. He thinks inflation could stay well above the Fed's 2% objective without more policy restraint, and he would rather see quick, modest rate increases than postpone action and risk having to tighten aggressively later.

For traders, the crucial point is that Musalem does not blame inflation solely on temporary supply disruptions. He identifies demand as an additional source of pressure, and company plans to raise prices by close to 3% heighten worries that inflation expectations could prove persistent. That leaves further Fed tightening a live possibility.

The market assigns a 55% probability to a Fed rate hike in October.