Donald Trump’s recent election win is expected to create new challenges for the Federal Reserve as it tries to balance economic growth with inflation control. Economists suggest that Trump’s proposed tariffs and strict immigration policies could lead to higher inflation, which may force the Fed to reconsider its plans. Currently, markets are signaling this concern, as seen in the movement of Fed fund futures and Treasury yields. The Fed, just starting a cycle of interest rate cuts, could find itself reconsidering further cuts if inflation picks up, given its historic reliance on raising rates to combat rising prices. Although markets anticipate a 25-basis-point cut at this week’s Fed meeting, the future outlook has become uncertain.
According to data from the CME FedWatch tool, the likelihood of another 25-point rate cut in December has dropped from 83% at the start of the month to 71% on Thursday. The odds of a similar cut in January have also fallen, from 44% last week to just 28%. Treasury yields jumped sharply post-election, with the 10-year bond yield rising by as much as 21 basis points, while the 30-year bond saw its largest yield increase since March 2020. Glen Smith, chief investment officer of GDS Wealth Management, remarked that this week’s anticipated rate cut might be the last for a while. He emphasized that the Fed’s guidance on future rate cuts will be closely watched by markets, especially with the recent postelection bond yield surge adding complexity to the Fed’s attempt to ease its policy stance.
Ahead of the election, economists expressed concerns over Trump’s economic plans, including tariffs as high as 20% on imports and 60% on Chinese goods, which they argued could raise consumer prices. Additionally, Trump’s proposed immigration policies could contribute to wage inflation by tightening labor supply. The Fed has worked to control such inflationary pressures over the past two years before it finally opted to lower rates in September. Nobel laureate economist Paul Krugman recently commented that Trump’s tariffs represent a major inflationary risk, noting, “We’re talking about an inflationary shock that is bigger than almost anything else you could do through federal policy.” However, consumer prices did remain relatively stable during Trump’s first term, even amid a trade war with China. This time, Trump is expected to take a broader approach to tariffs, potentially applying them on a global scale rather than focusing solely on China.
In addition to economic policy challenges, Trump may seek to reduce the Federal Reserve’s independence by influencing its rate-setting decisions. Allies of the president-elect reportedly discussed plans to reduce the Fed’s autonomy, which could involve giving the president a direct role in monetary policy or even removing Fed Chair Jerome Powell before his term ends in 2026. A study from the Peterson Institute of International Economics suggests that compromising the Fed’s independence could cost the U.S. economy $300 billion and lead to increased inflation. As markets look to the Fed’s meeting conclusion this Thursday, some analysts expect Powell might reference the impact of Trump’s election on the Fed’s outlook. However, economists at Pantheon Macroeconomics predict Powell will refrain from commenting directly on Trump’s future actions, as attempting to anticipate the incoming administration’s next moves could be risky. Instead, they believe Powell will likely adopt a diplomatic stance, which might offer the best chance of maintaining the Fed’s independence in the years ahead.
