Trump and the Fed: Battle lines

The potential for a conflict between the policies of the incoming Donald Trump administration and the Federal Reserve’s price stability mandate has been a topic of discussion since before the election. We have known for a long time – and in broad and unclear lines – what the political aspirations of the new president are. Lower taxes, lower immigration, higher tariffs, and a smaller current account deficit. Yesterday, the first signs came – again, broad and vague – of what the central bank’s response to all this might be.

The Open Market Committee cut interest rates by a quarter point, as expected. But the problem was not their actions, but rather their expectations. The summary of economic forecasts, last seen in September before the election, showed a 50 basis point increase in the expected interest rate for the end of next year. It is now 3.9 percent, which is just over two interest rate cuts compared to where we are today. Inflation expectations for 2025 rose by 40 basis points to 2.5 percent. Perhaps most important, the Committee’s uncertainty about inflation has increased significantly. The range of members’ inflation forecasts for 2025, from lowest to highest, was 30 basis points in September. Now he is 80.

The natural question in the face of this change is to what extent the elections changed the Commission’s prospects. Many journalists asked, focusing on the inflationary impact of tariffs. Powell’s answer, somewhat worryingly, had two distinct aspects. First he said this:

This is not the question before us now. We do not know when we will face this question. What the committee is doing now is discussing the pathways and understanding the ways in which tariffs can drive inflation in the economy. . . This puts us in (a) position, when we see what the actual policies are, to make a more nuanced and in-depth assessment of what might be the right policy response.

This seems reasonable. Then he said this:

Some people (on the committee) have taken a very tentative step and begun to incorporate very conditional estimates of the economic impacts of the policy into their forecasts at this meeting and they said so at the meeting. Some of them said they did not do it, and some of them did not say whether they did it or not…

Some have identified political uncertainty (as a reason) for more uncertainty about inflation. And the point about uncertainty is kind of the logical reasoning that when the path is uncertain, you go a little slower. It’s no different than driving on a foggy night or walking into a dark room full of furniture.

In the message, the two statements agree. Together they say that although Trump’s potential policies did not factor into the interest rate decision, they did in September. But they are inconsistent in spirit, because expectations in central banks are policy. This was evident in the market reaction yesterday. Facing a Fed concerned about Trump’s inflation and thinking more hawkishly as a result, the S&P 500 fell 3 percent, two-year bonds rose 14 basis points, and 10-year bonds rose 10 basis points. Small-cap stocks, favorites of Trump Trade, fell hard and have now given up all of their post-election gains:

Did Fed members make a mistake, thinking they knew what Trump’s policies would be, and how they would affect the interest rate path? In doing so, did they show some political bias? On both fronts, I’d say they probably did. Everyone seems to think they know what a second Trump administration will do. But the president’s erratic leadership style, his inconsistent cabinet choices, and his party’s narrow margins of control in both chambers of Congress mean that confidence on this issue is foolish. The arguments that tariff and immigration policy should cause persistent inflation are a bit shaky, exacerbate the problem of overconfidence, and reek of catalytic logic.

But before condemning Powell and his colleagues, we need to remember three things.

First: The Committee also had good non-political reasons to increase its inflation expectations. The last two inflation readings were in the Consumer Price Index frustratedand growth continued to be hotter than expected. In fact, many experts claimed that even today’s reduction was a mistake (imagine the market’s reaction if the committee stood its ground!). Some rewrites of 2025 forecasts were already in place; Don’t exaggerate the political aspect.

Second: No plan survives contact with the enemy. We are still in the realm of expectations. The real battle between Trump’s fiscal policy and the Fed’s monetary policy has not yet coalesced, and when it does the picture will change. It doesn’t have to be bloody. President Paul Volcker and President Ronald Reagan had an active tug of war in the 1980s, and the country was fine.

Finally: Do not over-read the market reaction. Stock valuations are historically high, and the bull market has been going on for a long time. Expectations that the Fed will cut interest rates next year are well established. In this environment, it wouldn’t take much of an increase in interest rate expectations to cause a disruption in the stock market. This is something Trump and Powell need to keep in mind.

Cars and 2025

We promised our 2025 forecasts would come today, but in the face of yesterday’s Fed meeting, they will have to wait. However, we got a lot of responses to people’s favorite cars. They have shown that unprotected readers are a diverse group. One reader emailed simply ‘Ferrari 286 GTB’; Another spoke lovingly of the 2008 Toyota RAV4. Some kept it up with electric cars from Tesla and BMW; Others went old school with the Volkswagen T4 camper van or the now-extinct Lancia Kappa. The auto industry is struggling, but people sure love their cars. Email us the worst you’ve ever owned: [email protected] and [email protected].

One hour is good

From Frankfurt with love.