"Two-Way Risks" Loom! US Fed Voter Predicts Significant Economic Slowdown, Inflation May Rise

Alberto Musalem, President of the Federal Reserve Bank of St. Louis, recently stated that as businesses and households face price increases due to new tariffs, US economic growth may "significantly" fall below trend levels, and the unemployment rate is expected to rise over the next year.

In an interview with the media, Musalem said, "I do not believe the economy will fall into a recession, but growth could indeed be notably below trend levels." He estimated the original "trend growth rate" to be around 2%.

"Currently, two-way risks are emerging," Musalem noted, pointing out that higher-than-expected tariffs will exert upward pressure on prices. At the same time, declining confidence and a sharp drop in stock markets have impacted household wealth, thereby curbing spending. All these factors combined will slow economic growth.

Musalem, who has voting rights on monetary policy at the Federal Open Market Committee (FOMC) this year, stated that the monetary policy response will depend on changes in inflation and unemployment in the coming months, whether the impact of tariffs on prices is persistent, and whether inflation expectations remain aligned with the central bank's 2% target.

"Anchored inflation expectations are a necessary condition for the US Fed to achieve its 2% target, but not a sufficient one. Now, our two goals face an imbalance," he said, referring to the dual objectives of maintaining low unemployment and stable inflation. "My stance is to closely monitor these two major risks going forward." He added that as long as inflation expectations remain under control, the US Fed will maintain a "balanced" approach.

Some argue that the impact of tariffs on inflation may be one-off, and thus, the central bank could theoretically "choose to ignore" it when formulating policies. Musalem, however, believes this approach is "very risky."

Similarly, if financial conditions and changes in household wealth persist for a longer period, they could also have a more profound impact on the economy. He also mentioned that if high tariffs are reduced in the future, the market could recover.

However, US Fed officials are increasingly concerned that the currently announced tariffs, coupled with retaliatory measures from other countries, could lead to more persistent inflationary pressures, necessitating tighter monetary policy. On the other hand, slowing economic growth could lead to rising unemployment, in which case the US Fed would lean towards easing measures.

Musalem stated that businesses have not yet indicated plans for layoffs but are cautious about future hiring and capital investment. "We have not heard about layoffs; what we are hearing is that businesses are 'waiting and seeing.'"

He said, "Even before the tariffs were introduced, I had predicted that the unemployment rate would gradually rise, very slowly, but still within the range of full employment... Now, this risk has increased."

Musalem stated, "I see high uncertainty... I see declining confidence among businesses and households, and it continues to decline. I see tariffs already substantially pushing up prices, reducing real income for individuals and businesses, and I also see retaliatory measures from trading partners."

"All of this means downside risks to growth and upside risks to inflation."

Regarding recent market volatility, Musalem said he is monitoring a range of financial market indicators and believes that financial conditions have tightened. He also views the recent dynamics in the stock and bond markets as a natural repricing of global growth risks.

"I do not believe the market is dysfunctional. Volatility is indeed high, whether in exchange rates, fixed income, stocks, corporate bonds, or commodities, prices are moving sharply and disorderly, but I have not seen any issues with market functionality."