Alberto Musalem, President of the St. Louis Federal Reserve, shared his views on how tariffs might influence inflation. He believes there is an equal chance—50/50—that tariffs could either cause long-lasting inflation or result in temporary inflation that lasts a few months. Musalem pointed out that uncertainty about tariffs remains and may continue through the summer. He optimistically suggested that this uncertainty could lessen by July, which might allow for a possible interest rate cut in September.

Market Forecasts

The market currently predicts an 86% chance of a rate cut happening in September. Musalem’s comments highlight potential economic changes depending on tariff developments. When discussing tariff policies, he explained that there’s a 50/50 probability that tariffs will either cause lasting price increases or lead to temporary inflation. This observation stems from the way import duties affect supply chains and raise prices. Traders know that if consumer prices stay high, it could delay central bank plans to lower rates. The uncertainty Musalem mentioned involves both policy outcomes and how businesses might adjust. If companies start stockpiling goods, changing supply routes, or preemptively raising prices, it could create wider inflation pressures. While uncertainty is common, what stands out now is its scale and duration. Musalem anticipates clearer direction by July, which could lower volatility and align with market expectations for a September interest rate cut.

Impact On Derivatives

When experts like Musalem discuss inflation and interest rates, they signal important changes for funding costs. A rate change in September would lower short-term borrowing costs for institutions, directly affecting derivative pricing like swaps and rate futures. However, if tariff clarity doesn’t emerge by late July, the likelihood of changing the rate path might decrease. With the market currently assigning an 86% chance to a September cut, the pricing of rate-sensitive instruments is already moving in that direction. Such certainty reduces options premiums and narrows spreads, which has direct effects for derivative traders. Even small shifts in confidence can change positions significantly. Musalem’s even-split probability prompts a different perspective. It’s not just about predicting inflation direction but also preparing for both outcomes. If July brings no resolution and increased instability in costs or trade routes, the Fed might keep rates steady for longer. This could lead to adjustments in the yield curve, likely flattening if long-term outlooks worsen while short-term policies remain tight. Reading policymakers is not just about waiting for decisions but also about timing. Statements tied to timelines, probabilities, and conditions indicate when changes are likely to occur. They also highlight key factors—like inflation surprises in June or disappointments in trade talks—that could signal turning points. Monitoring the speed at which the probability of a rate cut changes in response to trade news is crucial. This isn’t merely another forecast; it’s about setting expectations, adjusting risk levels, and signaling when to increase or decrease positions. Create your live VT Markets account and start trading now.

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