Trump will make the Fed’s job more difficult as rates fuel inflation and its independence is tested

• Trump’s election victory will likely make the Fed’s job more difficult.
• His tariff and immigration plans are expected to fuel inflation, complicating the Fed’s policy decisions.
• Trump has also said he would like a say in setting monetary policy, which would erode the Fed’s independence.

The Federal Reserve could soon hit a roadblock in its plans to keep the U.S. economy afloat while keeping inflation in check.

Donald Trump’s election victory brings his vision with it high trade rates and a drastic immigration policy that is moving closer to reality.

Economists widely view the proposals as inflationary, and markets appear to agree, with Fed funds futures and Treasury yields reacting similarly. It leaves the Fed with a conundrum: At a time when the Fed has only just begun its long-awaited rate cuts, the prospect of higher inflation could now bring the Fed to a standstill. After all, the Fed’s most important instrument to combat inflation is interest rates walks.

While traders are confident the Fed will implement a 25 basis point rate cut by the end of this week’s meeting, the outlook after that becomes bleak.

According to the CME FedWatch toolthe probability of a new cut of 25 points in December fell from 83% at the beginning of the month to 71% on Thursday. The likelihood of a similar rate cut at the January meeting is also lower, from 44% on November 1 to 28% on Thursday.

Meanwhile, the interest rate on government bonds is rose the day after the election, with the Interest on 10 year bonds to rise as much as 21 basis points to the highest level in months, while the yield on the 30-year bond has risen the most since March 2020.

Glen Smith, chief investment officer of GDS Wealth Management, said Thursday’s expected rate cut could be the last “for some time.”

“The Fed’s comments on the prospects for future rate cuts will be particularly important for markets given the recent post-election rise in bond yields, which will undoubtedly complicate the Fed’s efforts to move toward less restrictive policy,” he said. Smith. that markets are pricing in continued government spending and rising deficits.

In the run-up to the elections, economists warned about this Trump’s economic agendawhich includes tariffs of up to 20% on imports and 60% tariffs on goods from China, would raise prices, while his crackdown on immigration would lead to higher wage growth.

Both issues are factors the Fed struggled to control as it tried to cool the economy for two years before finally cutting rates in September.

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“The issue of tariffs is enormous,” Nobel Prize economist Paul Krugman said recently. “We’re talking about one inflation shock That’s bigger than almost anything you could do through federal policy.”

Yet the prospect of more inflation has not yet been fully confirmed. Consumer prices remained relatively stable during Trump’s first presidential term, during which he became embroiled in a trade war with China. The counter to that argument is that Trump wants to be much more aggressive with tariffs this time, and target them internationally, rather than solely at China.

A less independent Fed

Trump, meanwhile, could take steps to wrest control from the central bank when it comes to making policy decisions.

During the campaign, there were reportedly allies of the president-elect making plans to erode the Fed’s independenceThis would mean that the president would be involved in the rate-setting process and that Fed Chairman Jerome Powell could be fired before his term ends in 2026.

A study by the Peterson Institute of International Economics shows that interfering with the Fed’s independence could harm the economy $300 billion and further increase inflation.

As markets focus on the conclusion of Thursday’s Fed meeting, there is some expectation that Powell could nod to the incoming Trump presidency as he lays out the Fed’s plans for the future, though economists at Pantheon Macroeconomics say that this is unlikely.

“Mr. Powell will be wary of sending strong signals about the future direction of policy at the press conference, as doubting what President-elect Trump will do next has always been a hostage to fortune,” wrote the company.

They continued: “The Fed chairman will likely conclude that taking a diplomatic and uncritical tone offers the best chance of preserving the Fed’s independence over the next four years.”