Fed holds interest rates, risking ire of President Trump

Amid a spate of potentially inflationary Trump policies, Fed resists pressure to cut rates, drops reference to inflation steadily coming down.

30 January 2025

The US Federal Reserve (Fed) held interest rates at 4.5% (the current Fed Funds upper bound), as widely expected. The Fed’s primary mission of course is to keep inflation below the 2% target (along with keeping unemployment low) but achieving this has remained elusive for some time now. Currently headline US Consumer Price Index (CPI) inflation stands at an awkward 2.9% and Fed officials have been gradually guiding down earlier expectations of a steady loosening cycle, aligning with what the market has suspected for a while (see below chart).

Tellingly, the published minutes to the Fed meeting dropped the reference to inflation steadily coming down. As if managing all this was not complicated enough, Fed Chair Jerome Powell must now also contend with the new Trump administration. This is important for a number of reasons, not least because many of the new President’s signature policies look distinctly inflationary and actually appear to be going ahead (so much for ‘take him seriously but not literally’). Deporting all of the (11 million) undocumented migrants in America would deprive the economy of over eight million workers, particularly affecting the service and hospitality sectors. Similarly, stopping the H-1B visa programme could see the end of 85,000 high-skilled workers enriching the economy each year. And tariffs would be self-evidentially inflationary. According to one bank’s estimate, the proposals that stood as of late last year (an additional 10% blanket tariff on China and 25% on both Canada and Mexico) would generate an additional near-1% inflation in America’s core PCE (Personal Consumption Expenditures) measure which the Fed is known to follow closely. The US central bank will therefore have to grapple with the very real prospect of inflation not just continuing to fall but outright re-accelerating from here, suggesting in turn the final death of the easing narrative and a shift back to hawkishness. Indeed, officials including NY Fed President John Williams have already stated that the outlook remains highly uncertain “especially around potential fiscal, trade, immigration and regulatory policies”, and the latest Fed minutes duly confirm the institutional realisation of this shift.

‘Cut baby, cut’: Fed credibility matters in the Trump 2.0 era

But now things start to get murkier. While it will never admit to it, the Fed must be mindful of two conflicting factors when determining policy from this point on. The first is their credibility, which looks precarious given their previous high conviction that inflation was vanquished when now it is looking anything but. U-turns are notoriously hard to present as ‘all part of the plan’. The second factor is the direct pressure President Trump is placing on Chair Powell to lower rates while simultaneously increasing the need to raise them in the first place via his policy agenda. In the President’s mind, the guiding principle of central banking is as straightforward as that of energy production, ie ‘Cut baby, cut’, but his calls for Chair Powell to lower borrowing costs by “a lot” now pit him directly against the Fed’s rightly-cherished independence. Outwardly of course, the Fed cannot be seen to be making concessions to such political pressure, with all the attendant inflationary consequences. But some Fed officials will be privately wondering whether it might be politic not to provoke the President into asserting more control over the Fed in a fit of rage so soon into his new term. Investors pre-occupied with DeepSeek’s challenge to American AI dominance this week will do well to also keep an eye on this situation. It could yet be another source of unexpected disruption for a richly valued stock market.

Death by not many cuts - the Fed looks set to hold off on an aggressive easing cycle and thereby potentially trigger an existential crisis:

From 28 Jan 2025 to 27 Jan 2027