Federal Reserve Chair Jerome Powell is tiptoeing through a minefield as Donald Trump barrels toward his second term as president. The central bank is trying to maintain its image of neutrality while secretly bracing for the economic chaos Trumpâs policies could unleash.
Powell claims the Fed wonât speculate on Trumpâs plans, but insiders reportedly say a different game is being played behind the scenes. After Trumpâs November win, Powell went on the defensive, insisting the Fed wouldnât adjust interest rates based on âguessworkâ about future trade and immigration policies.
âWe donât guess, we donât speculate, and we donât assume,â Powell announced at a press conference. But as the dust settles, the Fedâs actions suggest otherwise. Trumpâs upcoming term is already affecting its inflation forecasts and interest-rate decisions.
Fedâs mixed signals
Last week, the Fed cut rates by another quarter point, making a full percentage point cut since September. Powellâs message was that the economy still needs some help. But projections released alongside the cut show a more hawkish stance for the future.
Officials are now predicting only two rate cuts in 2025 and two more in 2026, down from earlier expectations of four cuts next year. The inflation numbers donât help. The Fed now expects inflation (excluding volatile food and energy prices) to dip to 2.5% in 2025, worse than the 2.2% forecast just months ago.
And hereâs the thing: 15 out of 19 Fed officials now believe inflation could overshoot their forecasts. Back in September, only three saw that risk. Behind closed doors, Fed officials are sweating over the potential for Trumpâs trade and immigration policies to undo recent progress.
Powell, however, is playing coy, pointing to firmer inflation readings as the culprit. Meanwhile, the labor market and supply chainsâtwo big factors in the inflation cool-downâcould unravel. Powell himself admitted during a press conference that the Fedâs current-year inflation projections had âkind of fallen apart.â
Trumpâs immigration policies loom large over inflation
Trumpâs plans to crack down on immigration have Fed officials especially worried. His promises of mass deportations and stricter border controls could shrink the labor pool, tighten the job market, and send wages soaring. The supply-side expansion, which had been keeping inflation in check, could be thrown into reverse.
Governor Adriana Kugler, known for her hawkish tendencies, hasnât been shy about her concerns. While she backed a half-point rate cut in September, she recently hinted that further easing might not be possible if labor-force growth stalls.
The Fedâs models show a tight labor market could lead to higher prices, putting pressure on businesses to pass those costs to consumers.
Powell, however, has been trying to keep his colleagues from linking Fed policies directly to Trumpâs moves. Behind the scenes, heâs urging restraint, hoping to avoid the appearance of political bias. âWe need to focus on the data, not the politics,â Powell reportedly told colleagues.
The memory of 2018 is fresh in many minds. During Trumpâs first term, his trade war forced the Fed to lower rates to offset its economic impact. But this time, things are different. Inflation is no longer an abstract threat. Businesses and consumers are already wary of rising prices, making the Fedâs job even trickier.
Stress tests expose cracks in the banking system
While inflation and labor concerns dominate headlines, the Fed is also grappling with cracks in the banking system. The 2023 panic among mid-sized banks exposed weaknesses in the systemâs ability to handle rapid rate hikes. Stress tests, once a key tool for assessing banksâ resilience, have become a point of contention.
In 2019, the Fed proposed opening up its test models to public scrutiny, arguing it would make the system more transparent. Banks pushed back, claiming the models were too rigid and encouraged âgamingâ the system. The Fed eventually scrapped the idea, citing concerns over a âmodel monoculture.â
But the debate hasnât gone away. Banks argue that without consistent rules, they canât make meaningful long-term changes to their portfolios. And the lawsuit filed this week against the Fedâs stress test framework only adds to the pile.
Critics believe the tests are redundant, given the Fedâs other capital requirements, and could even encourage reckless behavior.
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