Trump Will Make Fed’s Job Harder As Tariffs Drive Inflation, Independence Challenged

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

The Federal Reserve may soon hit a roadblock in its plans to keep the US economy moving while controlling inflation.

Donald Trump’s election victory brings his vision of hefty trade tariffs and a sweeping immigration crackdown closer to becoming a reality.

Economists widely view the proposals as inflationary, and markets appear to agree, with Fed funds futures and Treasuries reacting in kind. That presents the Fed with a conundrum: At a time when it has just begun long-awaited rate cuts, the prospect of higher inflation may now give it pause. After all, the Fed’s primary tool to fight inflation has been interest rates walking tours.

While traders feel confident that the Fed will deliver a 25 basis point rate cut at the end of this week’s meeting, the outlook turns bleak after that.

According to CME FedWatch toolthe odds of another 25 basis point 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 have also fallen, from 44% on November 1 to 28% on Thursday.

Treasury returns, meanwhile, skyrocketed the day after the election, with it 10-year bond rate increasing a whopping 21 basis points to the highest level in months, while the yield on the 30-year bond rose 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 commentary on the outlook for rate cuts going forward will be particularly important to markets given the recent rise in bond yields following the election, which undoubtedly complicates the Fed’s efforts to move to a less restrictive policy,” Smith said, adding. that the markets continue to price public expenditure and increasing deficits.

Before the election, economists warned that Trump’s economic agenda, which includes up to 20% tariffs on imports and 60% tariffs on goods from China, would encourage higher prices, while his immigration crackdown would spur higher wage growth.

Both of these things are factors the Fed struggled hard to control as it tried to cool the economy for two years before finally cutting interest rates in September.

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“The tariff issue is huge,” Nobel economist Paul Krugman said recently. “We’re talking about an inflationary shock that’s bigger than almost anything else you can do through federal policy.”

Still, the prospect of more inflation is not yet fully confirmed. Consumer prices remained relatively stable during Trump’s first term as president, when he was locked in a trade war with China. The counter to that argument is that Trump wants to be far more aggressive with tariffs this time, focusing them internationally rather than solely 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.

During the campaign, allies of the president-elect reportedly made plans to erode the Fed’s independence, which would include inserting the president into the rate-setting process and potentially firing Fed Chairman Jerome Powell before his term ends 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 drive inflation higher.

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

“Mr. Powell will be wary of giving strong signals about the future direction of policy at the press conference, as guessing what President-elect Trump will do has always been a fortune-teller,” the firm wrote.

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