Following Donald Trump’s recent election victory, the Federal Reserve may soon face heightened challenges in its efforts to balance economic growth and control inflation. Trump’s policy proposals, particularly his aggressive stance on trade tariffs and plans for a substantial immigration crackdown, are viewed by economists as inflationary, and early market reactions seem to align with this view. Federal Reserve policy, which has recently included interest rate cuts, could now encounter obstacles if inflationary pressures arise, as the Fed traditionally responds to inflation with interest rate hikes.
Fed futures and Treasury yields responded immediately to the election results. The CME FedWatch tool now indicates lower probabilities for rate cuts in the near term, with chances for another 25-basis-point cut in December dropping from 83% at the start of the month to 71%. The likelihood of a similar reduction in January has also declined to 28%. Bond yields, including the 10-year and 30-year Treasury yields, surged notably, with the latter seeing its highest increase since March 2020. Glen Smith, Chief Investment Officer at GDS Wealth Management, noted that while the Fed is expected to deliver a 25-basis-point cut in the immediate term, future cuts are now less certain due to the postelection rise in bond yields and expectations of continued government spending.
Prior to the election, economists had expressed concern over Trump’s economic platform, which included up to 20% tariffs on imports, and even up to 60% tariffs on Chinese goods. His immigration plans are also expected to spur wage growth, which could add further inflationary pressures. Nobel economist Paul Krugman recently warned of potential inflationary shocks due to these tariff policies, calling it one of the most substantial risks federal policy could create. During Trump’s first term, consumer prices were relatively stable, despite a trade conflict with China, but this time, Trump’s approach appears more aggressive and broad-reaching.
Trump’s election win has also raised concerns over Federal Reserve independence. Reports suggest that some of Trump’s allies are considering ways to involve the president directly in monetary policy decisions, potentially undermining the Fed’s autonomy. Speculation has even surfaced that Trump might attempt to replace Jerome Powell, the current Fed Chair, before his term ends in 2026. Analysts from the Peterson Institute of International Economics cautioned that any move to erode Fed independence could cost the economy up to $300 billion and lead to higher inflation.
As the Fed’s Thursday meeting approaches, there is some anticipation that Jerome Powell may address the challenges posed by Trump’s policies, although economists at Pantheon Macroeconomics have indicated that Powell is likely to remain cautious and avoid speculation on the president-elect’s next moves. Instead, they suggest that Powell will adopt a diplomatic approach to maintain the Fed’s independence through the next presidential term.
