Powell will need to assure global investors that the Fed can manage the impact of Trump’s second term and the potential upcoming "Republican sweep."
The Fed is set to announce its latest interest rate decision at 3 a.m. Beijing time on Friday. Fed Chair Powell will then speak, with the first half of his remarks expected to be straightforward, but the latter half less so.
After the Fed announced the widely expected 25 basis point rate cut, Powell will have to face a series of questions about what Trump's return to the White House means for economic growth, inflation, and borrowing costs.
Trump's shocking election victory has caused global financial markets to crazily reprice. Powell will need to assure global investors that the Fed can manage the impact of Trump’s second term and the potential upcoming "Republican sweep," which has already changed expectations for the monetary policy path.
Trump vowed to impose comprehensive tariffs on U.S. imports and cut taxes on everything from corporate profits to overtime wages, policies widely believed to trigger inflation. He is also contemplating changes in the leadership of the Federal Reserve and claims to have some say over interest rates.
After the election results tilted towards the Republicans, investors increased their bets on the so-called Trump trade, which is based on accelerated economic growth but also higher inflation rates. On Wednesday, long-term U.S. Treasury yields jumped nearly 20 basis points, while U.S. stock markets hit record highs and the dollar rose.
Wall Street economists now believe the Fed's rate cuts will be smaller than before the election, as Trump's policy mix is brewing. JPMorgan still predicts the Fed will cut rates by 25 basis points this week and next month, but believes that thereafter the Fed will slow to cutting rates once every other meeting.
The pace of rate cuts will slow
Before the election, the U.S. economy is expected to achieve the much-anticipated soft landing. Although signs of fatigue have appeared in the job market, the inflation rate has declined toward the Fed's 2% target, and the unemployment rate has not surged. However, a series of new risks have emerged.
The Republican Party, led by Trump, has won the Senate, and if it continues to control the House of Representatives, Trump's ability to realize his policy agenda will be strengthened — a possibility that seems increasingly likely. He has also promised to deport millions of illegal immigrants.
Nomura Holdings recently predicted that under Trump's presidency, the inflation rate in 2025 would rise by 75 basis points. The bank currently expects the Fed to only cut rates once next year, although it anticipates four cuts before the election.
After the Fed raised rates to a 20-year high last year, it finally began to cut rates in September this year, with more evidence suggesting that the U.S. inflation emergency has ended. However, for many voters, the sting of rising living costs is crucial. Exit polls conducted by NBC News in key states show that about 22% of voters reported that inflation has caused them "serious difficulties" over the past year, while 53% reported "general difficulties."
The inflation experience in the post-pandemic era has made Fed decision-makers more sensitive to the risks of rising prices and the potential loss of support for expectations. Any signs of renewed inflation acceleration mean the Fed may either slow the pace of rate cuts or abandon cuts altogether, meaning that rates may not drop as low as previously predicted.
All of this means that the Fed's meetings may become more unpredictable. Economists and investors expect the Fed to cut rates by 25 basis points on Thursday. Stronger-than-expected economic data has alleviated concerns about a deteriorating labor market, making the smaller 25 basis point cut more acceptable.
Powell may try to present himself as politically neutral at the press conference following this week's decision, but given the stakes of the election and the potential for Trump's policies to change the economic and inflation outlook, investors will be highly alert to clues about how the Fed plans to guide the future.
Non-political
Like most central banks around the world, the Fed strives to operate outside of partisan politics. Powell has repeatedly stated that the Fed's job is to respond to the economy, not to preemptively act based on unimplemented policy proposals.
"We are a non-political institution," he said earlier this year. "We do not want to get involved in politics in any way."
But there is no doubt that Trump's return to the White House on January 20 could reshape the economic environment that the Fed must navigate.
Taxes: Trump promised to extend the tax cuts passed during his first term (which are set to expire at the end of next year) and further reduce corporate income taxes.
Trade: Trump calls for a minimum tariff of 10% to 20% on all imported goods, with tariffs on goods imported from China increasing to 60% or more.
Immigration: Trump has promised to carry out the largest mass deportation of unauthorized immigrants in history.
Energy: Trump's motto is "Drill, baby, drill," and he promises to cut regulations on oil, gas, and coal production and provide more federal land for fossil fuel production.
In addition to the inflation impact, economists also say that Trump's policy agenda is likely to lead to deeper deficits and a stronger dollar. In 2024, the U.S. fiscal deficit will reach 6.5% of GDP, resulting in the debt-to-GDP ratio rising to 100%.
How Trump's tax proposal will affect national debt
Bloomberg Economics estimates that Trump's proposals to extend income tax cuts and lower corporate taxes will lead debt to reach 116% of GDP by 2028. The largest version of Trump's tariff plan would raise prices during the same period by between 0.5% and 4.3% (depending on how many countries retaliate) and slow economic growth.
As for Trump's immigration plan, a reduction in workers means a decrease in consumption, but it also means a reduction in available foreign labor, leading to labor shortages in some sectors such as construction and healthcare.
There is also the Federal Reserve's own status as an independent policy maker. During Trump's first term, when the Fed raised interest rates in 2017 and 2018, Trump urged Powell to lower rates, breaking the White House's tradition of avoiding comments on monetary policy details.
Documents from the Fed during Trump's first term show that staff and officials forecasted the potential impacts of various scenarios (including raising tariffs and lowering taxes) on the economy and only acted once the policies were actually implemented.
How policy evolves
Powell and his colleagues are not the only central bank officials facing the implications of Trump being re-elected.
Due to the dominant role of the dollar in trade and finance, the Fed's monetary policy decisions will affect exchange rates and often force other countries to react.
This week, about 20 central banks globally (accounting for more than a third of global GDP) will decide on interest rates, including the Bank of England and the Swedish central bank, both of which are expected to cut rates.
Currently, the Fed can continue to focus on employment and prices. Even if the Trump administration comes to power, it will take time for him to enact new policies or for Congress to vote.
The Fed will not update its economic and interest rate forecasts at this month's meeting, with new forecasts set to be released in December. Powell may indicate that all options will remain on the table at the last meeting of the year, including keeping rates steady if the economy appears to be heating up again.
Powell has emphasized a method guided strongly by the latest data. As the world's largest economy prepares to change course under Trump’s leadership, Powell and his colleagues may be more inclined to act prudently.
