Fed Prepares to Cut Interest Rates Amid Uncertainty
As the Federal Reserve prepares to reduce its key interest rate for the second time in a row, the path forward is shrouded in uncertainty. The steady slowdown of inflation pressures, which contributed to Donald Trump’s presidential election victory, has led to this move. However, Trump’s economic proposals, which are seen as potentially inflationary, have cast a shadow over the Fed’s future decisions.
The Independence of the Fed Under Threat
The Fed has long prided itself on being an independent institution, free from political interference. Yet, Trump’s election has raised concerns that the White House may try to exert influence over the central bank’s policy decisions. During his previous term, Trump publicly attacked Chair Jerome Powell after the Fed raised rates to fight inflation, and he may do so again.
Conflicting Signals from the Economy
The economy is sending mixed signals, with solid growth but weakening hiring. Consumer spending has been healthy, leading to concerns that reducing borrowing costs may overstimulate the economy and re-accelerate inflation. Meanwhile, financial markets are throwing another curveball at the Fed, with investors pushing up Treasury yields since the central bank cut rates in September.
Rising Borrowing Costs
The result has been higher borrowing costs throughout the economy, diminishing the benefit to consumers of the Fed’s half-point cut in its benchmark rate. The average U.S. 30-year mortgage rate, for example, fell over the summer but rose again after the central bank cut its benchmark rate.
The “Trump Trade” and Its Implications
In what Wall Street has called the “Trump trade,” stock prices soared, and the value of bitcoin and the dollar surged. Trump’s plan to impose tariffs and carry out a mass deportation of undocumented immigrants would likely boost inflation, making it less likely that the Fed would continue cutting its key rate.
Inflation Concerns
Annual inflation, as measured by the central bank’s preferred gauge, fell to 2.1% in September. However, economists estimate that Trump’s proposed tariffs and taxes could send inflation back up to about 2.75% to 3% by mid-2026. Such an increase would likely upend the future rate cuts the Fed had signaled in September.
Uncertainty Ahead
Investors now foresee rate cuts next year as increasingly unlikely. The perceived probability of a rate cut at the Fed’s meeting in January of next year fell to just 28%, down from 41% on Tuesday and from nearly 70% a month ago. The jump in borrowing costs has set up a potential challenge for the central bank: Its effort to support the economy by lowering borrowing costs may not bear fruit if investors are acting to boost longer-term borrowing rates.
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