The Federal Reserve is set to announce its latest rate decision Thursday — and while it is widely expected to lower its key rate for the second time since September, Donald Trump’s electoral victory brings a new set of uncertainties — and, most likely, conflicts — for central bank policymakers.
As of Wednesday, Wall Street traders were almost unanimously that the Fed would cut the federal funds rate, which acts as a benchmark for other borrowing rates in the economy, by a quarter-point. The central bank is looking to dial back the restrictive lending environment it had put in place to rein in the surging inflation that took hold amid the pandemic.
With that cut, the central bank’s federal funds rate would fall back to about 4.5%.
Heading into Tuesday’s presidential vote, the Fed would have been justified in celebrating the return of inflation back to its 2% target.
At the same time, unemployment remains subdued at 4.1%.
In essence, the Fed has satisfied its dual mandate of keeping inflation and unemployment low.
But the arrival at that finish line now coincides with President-elect Trump’s promise to enact an entirely new fiscal and economic regime. While analysts remain uncertain about how exactly that regime could materialize and how severe it might be, markets have already responded by selling off bonds in anticipation of a return to inflation from a combination of Trump’s pro-growth and combative trade policies.
That would cause the Federal Reserve to pause its current trajectory of steadily lowering interest rates.
And that, in turn, would run directly counter to Trump’s goal to maintain lower interest rates as part of a policy of accelerating economic growth.
“Although Trump has shown a consistent preference for easy monetary policy, we believe that the Fed would engage in a less aggressive cutting cycle under a second Trump administration due to the inflationary nature of additional tariffs,” analysts with Nomura Holdings financial group wrote in a note to clients this case.
Trump and the GOP have denied the tariffs would be inflationary, pointing to Trump’s success in imposing tariffs in his first term without reigniting inflation.
“In his first term, President Trump instituted tariffs against China that created jobs, spurred investment and resulted in no inflation,” Anna Kelly, a spokesman for the Republican National Committee, has said.
Yet those tariffs, at $300 billion on selected Chinese goods, were much more targeted than the $3 trillion worth of blanket tariffs Trump is now expected to propose. And the inflationary environment is different now, too: During Trump’s first term, inflation only briefly ever climbed above 2%.
David Seif, chief economist for developed markets at Nomura, said Fed Chair Jerome Powell is likely to deflect any direct questions he gets Thursday about how he perceives that his role and responsibilities will change once Trump takes office.
It was Trump who appointed Powell to lead the Federal Reserve in his first term. But Trump has signaled a willingness this year to abandon the long-running principle of maintaining the Fed as an independent body.
“I think I have the right to say I think you should go up or down a little bit,” Trump said in a Bloomberg News interview at the Chicago Economic Club last month, according to Reuters. “I don’t think I should be allowed to order it, but I think I have the right to put in comments as to whether or not the interest rates should go up or down.”
Seif said that if Trump unleashes the full extent of the tariffs plan he has proposed, it would create “an acute inflationary event.” While it wouldn’t necessarily be permanent, Seif said, it would require the Fed to pause its monetary easing.
In general, growth is much more stable now. Trump’s policies, Seif said, could end up adding fuel to the fire — and force the Fed to act in a way Trump would not look favorably upon.