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Bond sell-off sent warning on Federal Reserve’s credibility, says top central bank official

Alberto Musalem says he supported dissenters’ calls for a quarter-point interest rate rise

Alberto Musalem speaks, gesturing with his hand, at an event for the Economic Club of New York.Alberto Musalem said: ‘At this juncture, earlier, incremental, gradual interest-rate action is preferable, less costly and less disruptive than potentially later, larger and abrupt actions’© Brendan McDermid/Reuters

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Claire Jones in Washington

Published2 hours ago

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A top Federal Reserve official has warned this week’s sell-off in US Treasuries is a signal that the central bank must earn its “credibility” on fighting inflation by backing up its rhetoric with interest rate rises.

“Mr Market spoke this week, and I took [a] signal from it,” Alberto Musalem, president of the St Louis Fed, told the FT.

“The signal emphasised to me that we need to continue to earn our credibility every day with both effective communications and actions as needed.”

The yield on 30-year US government debt hit its highest level since 2007 this week, peaking at 5.28 per cent amid concerns that the US central bank will struggle to contain the inflationary shock from President Donald Trump’s Iran war.

The rise came after the Fed held borrowing costs within a 3.5 per cent to 3.75 per cent range for the fifth time in a row — despite its preferred inflation measure coming in at more than double its 2 per cent goal ahead of the meeting.

Musalem, who does not hold a vote on the Federal Open Market Committee this year but sits on the rate-setting body, said he had “expressed a preference” for raising rates by a quarter point on Wednesday.

“There definitely are very large and meaningful supply shocks playing out in the global and US economy. At the same time, we have persistent demand pressures in the economy,” he said on Friday morning.

“The folks in my district, whether it’s businesses or households, continue to report broad-based price increases in both goods and services,” he added, voicing concerns that echo those of other regional Fed presidents.

A trio of FOMC voters representing regional Feds — Cleveland’s Beth Hammack, Dallas’s Lorie Logan, and Neel Kashkari of Minneapolis — backed a quarter-point rate rise on Wednesday.

On Friday, all three warned in separate statements that the Fed’s wait-and-see approach to regaining control of price stability risked bigger rate rises down the line should inflationary pressures swell.

Musalem agreed acting sooner rather than later was the best course for a central bank that has now missed its inflation target for more than five years.

“At this juncture, earlier, incremental, gradual interest-rate action is preferable, less costly and less disruptive than potentially later, larger and abrupt actions,” he said.

Traders expect the central bank to vote for a quarter-point rate rise in September, according to data from derivatives marketplace CME Group.

While data released on Thursday showed headline PCE inflation fell from 4.1 per cent in May to 3.7 per cent last month, the latest Iran war-induced rise in oil prices is expected to lead to an increase in price pressures in July.

Brent crude hovered around $90 a barrel on Friday, up from below $72 at the start of the month. Petrol prices have risen to $4.11 a gallon, from $3.85 a month ago, according to figures from motor club AAA.

Trump’s latest tariffs on US imports, the AI-induced investment boom and strong consumer spending are also feeding into higher costs for US businesses and households.

New Fed chair Kevin Warsh on Wednesday played down the need to respond to high inflation, partly on the grounds that market interest rates — affecting US businesses’ and households’ borrowing costs — had risen since the central bank’s meeting in mid-June.

Kevin Warsh speaks at a podium during a press conference, with two U.S. flags visible in the background.Federal Reserve chair Kevin Warsh’s tight-lipped approach to communications has already provoked a market backlash© Reuters

Musalem denied that Warsh’s comments implied the Fed was outsourcing monetary policy to markets.

“I firmly believe — and I observe that my colleagues, all 19 of them on the committee, are not outsourcing policy to markets,” the St Louis Fed president said. “Congress gave the FOMC the responsibility to achieve price stability and maximum employment. It did not give that responsibility to markets.”

He added: “Markets did some modest tightening of financial conditions before the meeting. That’s a statement of fact. I don’t think it’s outsourcing.”

Warsh believes previous Fed chairs’ hints at future policy moves — known as “forward guidance” — have led to central bankers becoming trapped by their own words and showing too little faith in investors.

By making the Fed less predictable, the new chair says markets will obsess less over what officials say and focus more on what is happening in the economy.

The New York Times on Friday reported Warsh has also mooted the idea of holding fewer policy meetings — though discussions are thought to be in early stages and any decision to do so is far from a done deal. The Fed declined to comment.

Warsh’s tight-lipped approach to communications has already provoked a market backlash, with investors accusing him this week of doing too little to explain why nine of the 12 voters on the FOMC had opted to hold rates.

Musalem, who previously worked at Man Group and Tudor, said he had “a very healthy respect for markets”.

“Markets are the best aggregators that we have — humanity has — of information in real time, and they send valuable signals,” he said. “They’re not always right, but they tend, on average, to be right.”

However, he added Fed officials also had a responsibility to explain their policy moves and clarify what central banks refer to as their “reaction function”.

“It’s very important to clearly communicate the reaction function to businesses, households and markets,” Musalem said. “They need to understand what we’re doing and why we’re doing it in certain situations.”

Additional reporting by Ian Smith in London and Kate Duguid in New York

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