- Donald Trump’s election victory will make the job of the Federal Reserve more difficult.
- His tariff and immigration plans are expected to boost inflation, complicating the Fed’s policy decisions.
- Trump has also said he would like a say in setting monetary policy, which would destroy the Fed’s independence.
The Federal Reserve may soon encounter a setback in its plans to keep the US economy afloat while also controlling inflation.
Donald Trump’s election victory brings his vision of high trade tariffs and a comprehensive crackdown on immigration closer to reality.
Economists widely view the proposals as inflationary, and markets seem to agree, with Fed fund futures and Treasury yields responding in kind. It presents the Fed with a conundrum: At a time when it is just getting started on long-awaited interest rate cuts, the prospect of higher inflation may now halt it. After all, the Fed’s main tool to fight inflation has been rates increases.
While traders feel confident that the Fed will deliver a 25-basis rate cut at the conclusion of this week’s meeting, the outlook gets dark after that.
According to the CME FedWatch tool, the odds of another 25-point rate cut in December have fallen from 83% at the start of the month to 71% on Thursday. The odds of a similar rate cut at the January meeting are also down, from 44% on Friday to 28% on Thursday.
Meanwhile, Treasury yields rose a day after the election, with the 10-year bond yield rising 21 basis points to a monthly high, while the 30-year bond yield rose more since March 2020 at the latest.
Glen Smith, chief investment officer at GDS Wealth Management, said Thursday’s expected rate cut could be the last “for some time”.
“The Fed’s commentary on the outlook for rate cuts going forward will be particularly important to markets, given the recent post-election rise in bond yields, which undoubtedly complicates the Fed’s efforts to move to a more accommodative stance. less restrictive policy,” Smith said, adding that markets were the price of continued government spending and widening deficits.
Before the election, economists warned that Trump’s economic agenda, which includes tariffs of up to 20% on imports and 60% tariffs on goods from China, would drive higher prices, while his crackdown on immigration would spur higher growth. high wages.
Both of those things are factors the Fed struggled to control as it tried to calm the economy for two years before finally cutting rates in September.
“The tariff issue is huge,” Nobel-winning economist Paul Krugman said recently. “We’re talking about an inflationary hit that’s bigger than almost anything else you can do through federal policy.”
However, the outlook for more inflation has yet to be fully confirmed. Consumer prices remained relatively stable during Trump’s first term as president, which saw him locked in a trade war with China. The counter to this argument is that Trump wants to be much more aggressive with tariffs this time around and focus them internationally rather than just on China.
A less independent Fed
Trump, meanwhile, could take steps to wrest control from the central bank when it comes to making policy decisions.
While he was on the campaign trail, allies of the president-elect were reported to be making plans to erode the Fed’s independence, suggesting the president’s involvement in the rate-setting process and firing Fed Chairman Jerome Powell before his term ends. to end in 2026.
A study by the Peterson Institute of International Economics said interfering with the Fed’s independence could cost the economy $300 billion and increase inflation.
As markets turn to the conclusion of the Fed meeting on Thursday, there is some expectation that Powell could influence Trump’s incoming presidency as he lays out the Fed’s plans for the future, although economists at Pantheon Macroeconomics said that was unlikely.
“Mr. Powell will be wary of giving strong signals about the future direction of policy at the press conference, as second-guessing what President-elect Trump will do next has always been a matter of luck,” the firm wrote.
They continued: “The Fed chairman is likely to conclude that striking a diplomatic, non-critical tone offers the best chance of preserving the Fed’s independence over the next four years.”