The Federal Reserve is expected to announce another interest rate cut today, making it the third reduction this year.
With inflation cooling and the labour market softening, the Fed is likely to lower its benchmark rate by a quarter-point, bringing it down to 4.5%-4.75%.
But this decision comes at a risky time.
Concerns about the Federal Reserve’s independence are intensifying as President-elect Donald Trump’s return to office.
What will influence the Fed’s decision today and what does the re-election of Donald Trump mean for the potential political influence on the Fed’s decisions and leadership moving forward?
The current state of the economy
A primary driver for today’s expected rate cut is the impact of tight credit conditions across the economy.
The Fed’s most recent Senior Loan Officer Opinion Survey shows that banks are maintaining strict lending standards across various loan categories, even as demand for loans remains weak.
While demand has started to stabilize, it remains lower than historical averages, creating additional pressure on job growth as businesses face challenges in securing financing.
The tight credit environment is significant for job growth.
Some economists estimate that stringent lending conditions could add half a percentage point to the unemployment rate by the end of 2024.
With the unemployment rate currently at 4.1%, this additional pressure could contribute to slower economic growth, reinforcing the Fed’s decision to ease borrowing costs.
Another important factor in the Fed’s decision-making is the recent rise in long-term borrowing costs.
The 10-year Treasury yield recently spiked to around 4.3%, increasing by over 50 basis points since the Fed’s last rate cut in September.
This rise is driven by strong economic data and concerns about possible fiscal policies under a Trump administration, which could include tax cuts and increased spending.
If long-term rates remain elevated, the Fed might adjust its strategy, possibly slowing the pace of rate cuts to avoid overstimulating the economy.
What are Trump’s plans for the Federal Reserve?
As Trump prepares for a second term, his stance on the Fed’s role in the economy has become a focal point.
During his campaign, Trump stated that he believes the president should have influence over the Fed’s decisions, specifically on interest rates.
He also suggested that he would replace Fed Chair Jerome Powell when Powell’s term expires in 2026, having criticized the Fed’s previous policy choices.
Trump’s history with the Fed is already contentious.
In 2018, he considered removing Powell over disagreements on rate hikes, arguing that his own business instincts might be better suited to guide the economy.
While legal experts say a president cannot remove the Fed chair without cause, Trump will have an opportunity to appoint new members to the Fed’s Board of Governors, starting in January 2026.
His party’s recent Senate victory could smooth the path for these appointments, allowing Trump to shape the Fed’s policy direction if his appointees align with his preference for low-interest rates.
What’s at stake with Fed independence?
An independent central bank is widely seen as essential to managing inflation and maintaining economic stability without political interference.
Countries with central bank independence generally experience more stable inflation rates and less interest rate volatility.
Powell has frequently emphasized that the Fed’s independence benefits the economy, and his stance reflects a broader consensus among economists who believe that political influence over monetary policy could lead to decisions that prioritize short-term gains over long-term stability.
The US has a history of presidents applying both public and private pressure on the Federal Reserve.
For example, in the 1960s, President Lyndon B. Johnson pressured Fed Chair William McChesney Martin to lower rates.
Similarly, Richard Nixon’s administration pushed the Fed to prioritize economic growth over inflation control in the 1970s, which some economists argue contributed to the high inflation rates of that decade.
Trump’s public criticism of Powell and the Fed’s policies during his first term mirrors this history and signals that similar pressures may arise during his second term.
If Trump continues to push for a say in the Fed’s decisions, it could challenge the central bank’s independence and alter how it approaches its dual mandate of price stability and maximum employment.
Trump’s influence on Fed policy could be particularly strong if he installs appointees who favor accommodative policies, potentially leading to lower interest rates.
However, Powell and other Fed officials have repeatedly stated their commitment to an independent policy approach that prioritizes the long-term health of the US economy.
How will the Fed respond to political pressures?
Despite the potential impact of Trump’s return to office, the Fed’s stated focus remains on stable prices and full employment.
Powell has indicated that the Fed will take a “wait-and-see” approach regarding new economic policies from the administration, preferring to evaluate their impact before making any significant changes.
Today’s expected rate cut aligns with the Fed’s cautious approach as it seeks to support the economy while balancing inflation control and job growth goals.
Trump’s planned economic policies could add complexity to the Fed’s task.
Proposals such as tax cuts, higher government spending, and protective trade measures might stimulate the economy in the short term but also carry the risk of increasing inflation.
Should inflation rise, the central bank might have to keep interest rates higher than anticipated to maintain price stability, potentially creating a challenging balancing act between economic growth and inflation control.
What’s next for the Federal Reserve?
Market forecasts suggest that the Fed may continue cutting rates through 2025, with some estimates predicting an additional 1% decrease in the benchmark rate by year’s end.
However, the combination of rising long-term yields and a restrictive credit environment adds uncertainty to this outlook.
The Fed might consider a temporary pause in rate cuts starting in January to assess the economy’s direction more thoroughly.
As the central bank trims its bond holdings — having reduced nearly $2 trillion in Treasuries and mortgage-backed securities since June 2022 — the rate cut cycle could slow the pace of balance sheet reductions.
Fed officials have suggested that bond runoff will continue in the background but may receive closer scrutiny if economic conditions require additional support for lending.
Ultimately, as the Federal Reserve meets today, it faces not only economic pressures but also the potential for political challenges under Trump’s presidency.
The anticipated rate cut reflects the Fed’s ongoing response to moderating inflation and weakening job growth.
Yet, Trump’s re-election could introduce some level of uncertainty in US monetary policy, raising questions about the future of Fed independence.
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