Current policy remains appropriate if trade tensions are durably de-escalated

Even after the recent U.S. and China trade detente, the labor market looks likely to weaken and prices to head higher, St. Louis Federal Reserve President Alberto Musalem said on Tuesday - though if the de-escalation proves durable the Fed’s current monetary policy stance could “remain appropriate.”

Eased trade tensions, Musalem told the Economic Club of Minnesota, would allow the labor market to stay strong and inflation to remain on path to the Fed’s 2% goal.

“In this scenario, the current stance of monetary policy, which is focused on bringing inflation back to 2% in the context of a full-employment labor market, will remain appropriate,” he said. But that’s only the case, he said, if the public continues to believe that inflation will come down, a faith that could be shaken if prices stay elevated.

“I believe policy should prioritize price stability in the face of persistent inflationary pressures that threaten to dislodge long-term inflation expectations,” Musalem said.

And, he added in a discussion following his prepared remarks, even with anchored inflation expectations the Fed wouldn’t necessarily lower rates if inflation remained too high and the economy wasn’t weakening too much.

The Fed earlier this month left short-term borrowing costs in the range of 4.25%-4.50%, and Fed policymakers speaking since then have signaled they plan to leave them there while they wait for more clarity on how trade and other Trump administration policies play out.

The ongoing and unusually high uncertainty over economic policy under the Trump administration, Musalem said on Tuesday, is prompting households and businesses to pause spending and investment, which will slow the economy in a “meaningful” way if it continues.

But with tariffs equally likely to lead to more persistent inflation as to only temporary inflation, the Fed should not commit to rate cuts to cushion the economy until there is more certainty about how inflation actually behaves, Musalem said.

In an already bad week for long bonds, an aggravated inflation picture around the world has added another irritant. I discuss this and all the market news below.

Be sure to check out my column today, where I explore why key foreign creditors might be reassessing their holdings of U.S. debt and what this could mean for funding America’s rising deficit.

Today’s Market Minute

* President Donald Trump’s tax cut and spending bill faces a critical stress test on Wednesday as Republicans try to overcome internal divisions about cuts to the Medicaid health program and tax breaks in high-cost coastal states.

* Companies importing goods into the United States from China are rushing to convert warehouses into facilities that are exempt from President Donald Trump’s tariffs until they are ready to sell the merchandise.

* Oil prices gained more than 1% on Wednesday after reports of Israel preparing a strike on Iranian nuclear facilities raised fears that a conflict could upset supply availability in the key Middle East producing region.

* Britain suffered a bigger-than-expected inflation surge in April, including in areas watched closely by the Bank of England which investors now believe will have to slow its already gradual pace of interest rate cuts.

* Morgan Stanley upgraded its stance on U.S. equities to “overweight”, citing a slowing but still expanding global economy despite policy uncertainty.

* Japanese exports rose 2% in April from a year earlier but shipments to the U.S. fell 1.8%, data from the Ministry of Finance showed on Wednesday.

* Global electricity generation from solar farms is set to exceed output from nuclear reactors for the first time this summer, marking an important milestone in the continuing growth of solar power within global energy systems.

Bad week for bonds

Britain and Canada reported above-forecast core inflation jumps for April over the past 24 hours - cutting across interest rate easing expectations in both countries and sending long-term government borrowing costs higher for both.

On top of that, the crude oil prices jumped more than 1% on Wednesday and briefly clocked their highest in a month after CNN reported Israel was preparing to strike Iran’s nuclear facilities.

The darker global inflation picture comes as U.S. Federal Reserve officials remain wary of tariff-related price hikes in America.

Atlanta Fed chief Raphael Bostic said U.S. businesses may have run out of strategies to delay changing prices or employment in response to higher import taxes and the economy could soon face a wave of price increases.

“If these pre-tariff strategies have run their course, we’re about to see some changes in prices, and then we’re going to learn how consumers are going to respond to that,” said Bostic.

Another Fed interest rate cut is now not fully priced into futures markets until October.

This latest bout of inflation anxiety comes at a nervy moment in bond markets, with Japan’s ultra-long government bond yields spiking sharply this week after a poor debt auction there.

The U.S. Treasury is now due to sell some $16 billion of 20-year bonds later on Wednesday on the heels of Moody’s decision last Friday to remove the last U.S. AAA credit rating. Both 20 and 30-year Treasury yields are back above 5% and stalking their highest levels since 2023.