While the Federal Reserve proceeds with its second interest rate cut this year due to cooling inflation, the post-election landscape—especially the specter of Donald Trump‘s proposed tariffs and challenges to central bank autonomy—introduces unprecedented uncertainty for economic stability and future policy.
The Federal Reserve is once again poised to cut its benchmark interest rate, marking the second such reduction this year. This move comes as inflation continues to cool, allowing the central bank to recalibrate its monetary policy. However, the path forward is anything but clear, as the recent presidential election has introduced significant uncertainty, particularly with the potential economic proposals of Donald Trump.
The Rationale Behind the Rate Cuts
Traditionally, the Fed cuts rates to stimulate a sluggish economy or a weak job market. Yet, the current economic climate presents a different scenario. The economy is growing briskly, and the unemployment rate remains low at around 4.1%. Despite this robust growth, the Fed is lowering rates as part of what Chairman Jerome Powell has termed a “recalibration” to a lower-inflation environment.
This approach follows a period of aggressive rate hikes initiated in June 2022, when inflation soared to a four-decade high of 9.1%. The Fed responded by raising rates 11 times, reaching a peak of about 5.3%. With year-over-year inflation now significantly reduced to 2.4% (or 2.1% by the central bank’s preferred gauge), barely above the Fed’s 2% target, officials believe that high borrowing rates are no longer necessary. These high rates previously restricted growth, particularly in interest-rate-sensitive sectors like housing and auto sales. As former Fed economist Claudia Sahm noted, “inflation is no longer elevated. The reason for the restriction is gone.”
Post-Election Uncertainty: The Trump Factor
While the Fed’s immediate decision on rates is clear, its future actions are clouded by the outcome of the presidential election. Should Donald Trump take office again, his proposed economic policies could profoundly impact the Fed’s ability to continue its planned rate reductions.
Trump’s key proposals include imposing high tariffs—essentially, import taxes—on all imports, potentially as high as 10% across the board, and even higher on goods from China and autos from Mexico. He has also advocated for mass deportations of unauthorized immigrants. Economists are deeply concerned that these measures would almost certainly reignite inflation.
A report by the Peterson Institute for International Economics concluded that Trump’s main tariff proposals could make inflation 2 percentage points higher next year than it otherwise would have been. Similarly, economists at Goldman Sachs estimate that a 10% tariff, alongside other proposed taxes, could send inflation soaring back to 2.75% to 3% by mid-2026. Such an increase would force the Fed to slow or stop its rate cuts, and potentially even consider raising rates again.
A Challenge to Central Bank Independence
Beyond the inflationary impact of his proposals, Donald Trump has openly threatened to intrude on the Fed’s normally independent rate decisions. During his previous presidency, Trump publicly attacked Chairman Jerome Powell for raising rates. The Fed has long guarded its status as an independent institution, free from political interference, to make difficult decisions about borrowing rates. The prospect of renewed political pressure from the White House could undermine this critical independence.
Financial Markets and the “Trump Trade”
The financial markets have already begun to react to the post-election landscape, anticipating higher inflation, larger federal budget deficits, and faster economic growth under a Trump presidency. This phenomenon, dubbed the “Trump trade” by Wall Street, has seen stock prices soar and the value of cryptocurrencies like Bitcoin and the dollar surge. This investor sentiment has also pushed up Treasury yields, leading to higher borrowing costs across the economy, including for mortgages and car loans. This effectively diminishes the benefit of the Fed’s rate cuts for consumers, creating a challenge for the central bank.
Investors now foresee rate cuts next year as increasingly unlikely. For instance, the perceived probability of a rate cut at the Fed’s meeting in January of next year dropped significantly following the election, according to futures prices monitored by CME FedWatch.
The Neutral Rate Dilemma and Conflicting Signals
Looking ahead, the Fed will wrestle with determining how low its benchmark rate should ultimately go. Officials aim to reach a “neutral” rate—a level that neither restricts nor stimulates economic growth. While the Fed’s rate-setting committee estimated this to be around 2.9% in September, most economists believe it’s closer to 3% to 3.5%. With the current rate at approximately 4.9%, most officials are confident it remains restrictive.
However, some economists, like Joe Lavorgna of SMBC Nikko Securities, question the urgency of rate cuts when the economy appears healthy even with higher borrowing rates. They suggest the Fed may already be close to a neutral level. This debate is complicated by conflicting economic signals: strong GDP growth, fueled in part by investments in artificial intelligence, coexists with a weakening job market where it takes people nearly six months to find new positions, and hiring rates have collapsed to levels not seen since the 2008 global financial crisis, as reported by the Bureau of Labor Statistics.
Further complicating the Fed’s task is the impact of government shutdowns, which have impaired the availability of current economic data, including the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) index. This lack of comprehensive data makes informed policy decisions even more challenging.
Looking Ahead: What’s Next for the Fed?
While the Fed is set to cut rates again, the future is fraught with political and economic uncertainties. Christopher Waller, an influential Fed governor and potential successor to Powell, has expressed support for lower rates but also urged caution, stating, “We need to move with care when adjusting the policy rate to ensure we don’t make a mistake that will be costly to correct.” The central bank’s next interest rate decision is scheduled for December 10.
The Fed’s actions will largely hinge on how inflation and the job market evolve in response to both its current policies and the incoming administration’s economic agenda. The delicate balance between maintaining price stability and supporting employment will be tested as the central bank navigates these uncharted waters.
