Donald Trump is still weeks away from taking the oath of office, but the president-elect’s vow to enact a sweeping policy overhaul is already looming large over the Federal Reserve.
The Fed trimmed interest rates by a quarter of a percentage point on Wednesday in its third consecutive reduction, but officials’ projections for half as many rate cuts next year as they had forecast in September triggered big market swings.
Fed chair Jay Powell said that while the more cautious outlook for rate cuts was prompted by signs that progress on getting inflation down to the central bank’s 2 per cent target had stalled, some officials had also begun to include assumptions about Trump’s policies in their forecasts.
“Pretty much every prong of [Trump’s] policy looks like it’s going to threaten their mandate,” said Julia Coronado, a former Fed economist who now runs MacroPolicy Perspectives, referring to the central bank’s aims to keep inflation low and stable and maintain a healthy labour market.
Coronado added that the Fed’s message was clear: “We are not in Trump 1.0 any more. This is Trump 2.0, we have above-target inflation and we need to get ahead of this.”
Trump’s threats to impose tariffs, carry out mass deportations and slash taxes and regulations could have wide-ranging economic implications, said investors and analysts. Some economists are concerned that the overhaul will lead to higher inflation, lower growth and more volatility.
Economists acknowledged the groundwork for a shift to a more gradual pace of rate cuts next year was already taking shape before Trump’s election win in early November. Inflation readings in September and October came in higher than anticipated, supplanting fears about the labour market’s health that had bubbled over the summer.
The Fed’s preferred inflation measure, the core personal consumption expenditures price index, rose at an annual rate of 2.8 per cent in October and is forecast to have accelerated to 2.9 per cent in November, according to a FactSet survey of economists.
Powell noted these shifts on Wednesday and also made clear that after December’s cut, the Fed had entered a “new phase” in which it needed to be much more “cautious” about its actions given interest rates were now closer to officials’ best estimates of a “neutral” level that neither slows nor accelerates growth.
While the Fed’s policy settings were still “meaningfully restrictive”, Powell made clear that more cuts would depend on further progress on inflation.
But Powell also signalled a marked shift in the way the Fed was considering the changes that Trump has vowed to enact, diverging from his stance in the aftermath of November’s election that the Fed would not “speculate” or “assume” anything about what the next administration would do.
This was most visible in the revised set of officials’ economic projections published by the central bank alongside the rate decision. Rather than a full percentage point worth of reductions for next year, which was forecast in September, most officials projected only half a point. They also scaled back their estimates for 2026 and 2027.
Officials also sharply raised their median forecasts for inflation. The “central tendency” for the core PCE price index — which excludes the three highest and three lowest estimates — jumped to a range of 2.5-2.7 per cent. That is up from 2.1-2.3 per cent in September.
The scale of adjustments cascaded through financial markets on Wednesday, sending the S&P 500 index down nearly 3 per cent, pushing the dollar to a two-year high and elevating yields on US government debt. Asian equities came under pressure early on Thursday.
Dean Maki, chief economist at hedge fund Point72, called the Fed’s shift “striking” and said it was rooted in speculation about Trump. “It’s hard to see why they would have expected so much higher inflation if they are not incorporating things like tariffs into the forecasts.”
JPMorgan strategists echoed that sentiment. “Below the surface, we can see tariff concerns could be seeping through to [the] Fed’s psyche,” they said.
Speaking to reporters on Wednesday, Powell acknowledged that some officials had taken a “very preliminary step” to incorporate “highly conditional estimates of economic effects of policies into their forecasts at this meeting”.
Asked directly about how the Fed was thinking about its policy response to tariffs, the chair said the committee was “discussing pathways” and working to better understand how such policies would affect the economy.
“It puts us in position, when we finally do see what the actual policies are, to make a more careful, thoughtful assessment of what might be the appropriate policy response,” he said.
A cut at the Fed’s next meeting, in January, is “absolutely off the table”, said Ellen Zentner, chief economic strategist for Morgan Stanley Wealth Management, citing the inclusion of language in the policy statement that has been used in the past to signal a prolonged pause.
Derek Tang, an economist at research group LHMeyer, expects the Fed to hold off on additional cuts until June and eventually deliver a total of three for the year. That forecast hinges on inflation expectations staying in check.
Tang said he was also worried about the labour market weakening more than expected should Trump’s policies dent growth, which could create complications for the Fed.
“People may be underweighting the scenario where the labour market does weaken and the Fed is now caught between higher inflation but also trying to stop the economy from entering a recession,” said Tang. “It’s a double whammy.”