St. Louis Fed President Alberto Musalem said inflation is almost a full percentage point above the Fed’s target, while the labour market is cooling in an orderly way. He spoke at the Missouri Athletic Club Speaker Series on Wednesday.
He said his baseline outlook is for the economy to grow at or above 2%, with financial conditions accommodative and supported by deregulation and fiscal tailwinds. He expects unemployment to stabilise around 4.3% or 4.4%.
Inflation And Labor Market Backdrop
Musalem said about half of excess inflation comes from tariffs and expects this to fade as the year progresses. He also said inflation could stay higher for longer, though this is not his baseline.
He said the job market is vulnerable to a rise in layoffs, but that is not his base case. He added that policy is balanced appropriately and is neutral now in real terms.
He said a government shutdown may have biased CPI inflation downward and that this effect could last through April, making PCE inflation a better gauge. He said the Fed needs to finish bringing inflation back to target, which could support consumption and growth and could lower the 10-year rate.
He said he is looking forward to learning what Warsh’s priorities might be and expects the Fed to keep focusing on its dual mandate under a new chair.
Market Implications In 2026
Looking back at the thinking from 2025, we were banking on fading tariff effects to bring inflation down. However, the most recent January 2026 CPI report showed inflation is still stubborn at 2.6% year-over-year. This persistence is making the path back to the 2% target look longer than anticipated.
The labor market is also showing signs of a continued, orderly cooling, just as was expected last year. The January 2026 jobs report showed the unemployment rate edging up to 4.2%, which is still historically strong. For traders, this removes any pressure on the Fed to cut rates due to a weakening job market, reinforcing a “higher for longer” stance.
A major shift from last year’s outlook is the change in Fed leadership, something that was only being speculated on then. With Chair Warsh now confirmed and leading the Fed, the market is pricing in a more hawkish stance. His public statements have emphasized finishing the job on inflation, echoing historical periods like 2022 when central bank resolve was tested.
Given this new uncertainty, betting on continued low volatility is a risky play. We are seeing increased demand for options protecting against a rise in interest rate volatility, as the chance of a rate cut before mid-year has all but vanished from futures markets. Strategies that profit from a sideways or range-bound market could be favorable as the Fed stays on hold.
Last year’s view of accommodative financial conditions is now being challenged. The 10-year Treasury yield has climbed 25 basis points in February 2026 alone, reaching 4.5% as markets recalibrate expectations under a more hawkish Fed. This suggests that the “neutral” policy of 2025 is now perceived as not being restrictive enough to finish the job.
