Fed signals more rate hikes likely as inflation pressures persist

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Fed signals more rate hikes

Highlights

Fed official Musalem signals further rate hikes likely as underlying inflation remains about 1 percentage point above target and moves higher.
The Personal Consumption Expenditures Price Index was 3.7% year over year in July versus 2.3% in April 2025, with commodity shocks and strong demand complicating the outlook.
Market pricing implies three more 25-basis-point hikes through April, while Fed officials' projections show one more increase this year and possible action in 2027.

Musalem outlines case for further tightening

As reported by Reuters, Musalem says the Fed will likely need to raise interest rates further because inflation pressure is coming from both persistent domestic demand and supply-side shocks that now extend beyond oil. He says earlier, incremental tightening would be less disruptive than delaying action and then needing larger increases later.

Musalem, who is not currently a voting member of the Federal Open Market Committee, does not comment on the Fed's next specific move or where the policy rate may need to peak. Still, he says policy must place meaningful restraint on inflation if the central bank is to return price growth to target over roughly the next 18 months.

He says inflation is already embedded rather than a remote risk, adding that even after excluding oil and other supply-related factors, underlying inflation may still be running about 1 percentage point above target and moving in the wrong direction. The Fed last week raised rates by 25 basis points and also removed language in its policy statement that had attributed recent inflation partly to supply shocks, a shift that reflects growing concern that price pressures will not fade on their own.

Commodity shocks and strong demand complicate outlook

The Fed's preferred inflation gauge, the Personal Consumption Expenditures Price Index, stands at 3.7% year over year in July, compared with a recent low of 2.3% in April 2025. The article says import tariffs introduced by the Trump administration were followed this year by the U.S.-Israeli war with Iran, which pushed fuel costs higher globally, while prices for commodities such as copper also rise alongside heavy artificial intelligence-related investment.

Musalem says U.S. spending and growth remain resilient, which supports the economy but also adds to inflation pressure. He describes the current policy rate of 3.75% to 4.00% as still accommodative, indicating it is not yet high enough to materially restrict activity.

Market pricing currently points to three more quarter-point increases over the next five policy meetings through April, while Fed officials' median projection after last week's meeting shows one more increase this year and a near-even split over another move in 2027. Even so, Musalem says tighter policy does not necessarily require weaker employment or a recession, arguing the labor market is stable, balanced and near full employment even as businesses report sharply higher input costs and plan further price increases.

In our earlier article on Austan Goolsbee’s warning about shifting inflation drivers, we explained that the Fed is increasingly focused on whether today’s price pressures are rooted in overheating demand rather than just an oil-related supply shock. We also noted his view that sticky services inflation and AI-linked investment could keep inflation elevated, potentially requiring a more aggressive, frontloaded path of rate hikes.

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