How will Trump's second term impact the Fed?

The Federal Reserve is cutting interest rates and officials say the economy is performing well, but the incoming Trump administration presents uncertainties for the central bank’s monetary policy and potentially its independence, sources said.

For now, the Fed and Chair Jerome H. Powell are in wait-and-see mode.

“I think we have time to make assessments about what the net effects of policy changes will be on the economy before we react with policy,” Powell said at a Nov. 14 event. “That’s not to say we won’t be doing quite a lot of analysis.”

A Republican-controlled Congress and White House is largely expected to focus on tax cuts next year. Many of the provisions in the Republican’s 2017 Tax Cut and Jobs Act will expire in late 2025. On the campaign trail, now President-elect Donald Trump floated tax cuts beyond extending the 2017 provisions, including no taxes on tips or Social Security payments.

Trump has also promised major tariffs. That includes a universal baseline tariff on all U.S. imports of 10% to 20% and a 60% tariff on all U.S. imports from China. Shortly before the Nov. 5 election, he suggested replacing the federal income tax with proceeds from tariffs.

To date, no specifics for these plans have been announced and Trump is still about two months away from taking office. That means Powell and other Fed officials won’t alter their economic forecasts just yet.

“In the near term, the election will have no effects on our policy decisions,” Powell said Nov. 7, noting he doesn’t know the timing, substance or economic impacts of any potential Trump administration changes.

The Federal Open Market Committee on Nov. 7 approved a quarter-point interest rate cut, a move that followed a half-point cut at its September meeting.

Powell has said the Fed will continue its rate-cutting path as inflation nears its 2% target, but isn’t on a preset policy course.

“The economy is not sending any signals that we need to be in a hurry to lower rates,” Powell said Nov. 14. “The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully. Ultimately, the path of the policy rate will depend on how the incoming data and the economic outlook evolve.”

Tiffany Wilding, managing director and economist at Pacific Investment Management Co., said the U.S. economy is heading toward a soft landing after a turbulent period that featured a global pandemic, government stimulus, high inflation and energy price shocks brought by Russia’s invasion of Ukraine.

“Now of course, there’s additional policy uncertainty given the Trump administration’s campaign rhetoric, but overall, we’re still moving out of this pandemic-related unique period,” she said. “That would argue for central banks to move their interest rates down closer to neutral in order to be more reflective of where their economies are today.”

Until there’s more certainty on the Trump administration’s policy, it’s more likely the Fed will proceed cautiously, Wilding added.

The Fed’s next meeting is Dec. 17-18. Market participants predict there is a 62% chance the committee will initiate another quarter-point cut at that meeting, according to the CME FedWatch Tool that tracks trading in the 30-day fed funds futures.

At its September meeting, the committee projected multiple quarter-point rate cuts in 2025. It will release updated projections in December that will factor in updated economic data on inflation and employment.

The consumer price index rose in October an annualized 2.6% from a year earlier, above the 2.4% figure recorded in September, while the unemployment rate held steady at 4.1% in September and October.

Neel Kashkari, president and CEO of the Federal Reserve Bank of Minneapolis, was asked Nov. 12 how Trump’s tariff policy could impact the Fed, but he also said it’s too early to tell.

“Where it becomes complicated is how the other country responds,” Kashkari noted. “So if there’s a tit-for-tat — and increase in tariffs from the U.S., a response from other countries and it goes back and forth — then you could imagine a longer-term inflationary impact.”

Neil Sun, portfolio manager at RBC Global Asset Management’s BlueBay fixed-income team, said increased tariffs will likely cause inflation to rise, which could change the Fed’s outlook.

“This will potentially put a halt, if not a re-hike, to the current policy rate normalization process for the Fed,” Sun said. “The Fed will be concerned about an inflation comeback.”

When asked Nov. 14 about immigration policy, Powell declined to speculate how mass deportations could impact the economy. He was then asked, “What does it mean if the workforce shrinks?”

In response, Powell said, “I think we can do the arithmetic: If there are fewer workers, there’ll be less work done. I just don’t want to go there. This is getting me into political issues that I really want to stay as far away from as I possibly can.”

Powell has led the Fed since 2018 and has consistently preached the benefits of its independence from politics.

But during his first term, Trump was publicly critical of Powell’s monetary policy and frequently tweeted about his desire for lower interest rates.

Trump didn’t try to fire Powell during his first term — and it’s a question as to whether he legally could — but his advisers have floated the idea. In June, Trump told Bloomberg that he’d let Powell serve out the remainder of his term, which expires in 2026, “Especially if I thought he was doing the right thing.”

When asked Nov. 7 if he would resign if Trump asked, Powell said he would not. And when asked if the president has the power to fire or demote the Fed chair, Powell responded, “Not permitted under the law.”

Donald Kohn, former vice chair of the Fed, who is now the Robert V. Roosa chair in international economics at the Brookings Institution, said Powell attempted to stay out of politics with his answers. “The markets will be reassured by that attitude by Jay Powell,” he added.

Trump has also flirted with the idea of having a say over Fed policy. Last month, Trump said, “I think I have the right to say, ‘I think you should go up or down a little bit.’ I don't think I should be allowed to order it, but I think I have the right to put in comments as to whether or not interest rates should go up or down.”

PIMCO's Wilding said the Fed maintaining independence will serve any administration better than the alternative.

“Our expectation is everyone understands the importance for broader market functioning and the credibility of the Treasury market that you have an independent Fed,” she said.

Markets view Powell “as a steady hand at the helm and that will continue to be the case until mid-2026 when his (term) is over,” Wilding added.