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The writer is vice-chair of Evercore ISI and a former member of the management committee of the New York Fed
Investors are grappling with what a second Trump presidency would mean for the US economy, the Federal Reserve and interest rates, even as they also weigh the possibility that vice-president Kamala Harris might turn the tables.
There are two aspects to the debate — potential pressure from Trump on the Fed and the impact of Trump policy shocks on the economy and rates. The more extreme scenarios are ones in which political pressure prevents a timely response to the shocks.
Trump has urged the Fed not to cut rates soon with inflation still too high, which many read as meaning a cut before the election this November would not be justified. This will not prevent the Fed from cutting rates in September but makes it additionally important for it to set out its case methodically, one reason why there is unlikely to be an early cut at this week’s meeting.
Most investors assume that, once in office, Trump would then press the Fed to lower rates. Aggressive “jawboning” seems likely, though the head-on assault on Fed independence floated by some would-be Trump advisers will probably not materialise, and would likely be shut down by a jump in bond yields and sell-off in equities if it did.
Any political pressure would make it harder at the margin for the Fed to cut rates while preserving inflation credibility. Fed chair Jay Powell is likely to keep his head down, get on with his job and rely on Congress to provide some insulation from the executive branch. But the Fed would still need to consider the potential impact of Trump policy shocks.
The Fed’s current Summary of Economic Projections is de facto a “constrained Harris” forecast. This is simply because it assumes no new shocks, likely in a scenario in which Harris wins but is limited by a Republican Senate. But Trump is a disrupter. Changes in market prices signal investors think Trump’s trade, immigration, fiscal, energy and deregulation policies would be reflationary overall, pushing nominal GDP and inflation higher.
This presents the Fed with a dilemma: update its policy plans early in light of prospective shocks or wait and risk falling behind the curve again. It seems likely it will err in the direction of only slowly adapting for potential shocks, updating its baseline forecast after the election and only then cautiously.
The Fed does not know who will win, has no edge in judging what will be implemented, and will be keenly aware of the difficulty of modelling both the mechanical impacts and the effects on animal spirits and risk premia. It will not want to look as if it is prejudging Trump policies as inflationary during election season. Helpfully, bond yields are doing some of its work for it, moving higher when Trump victory odds improve, which leans against overheating.
Some Trump shocks — tariffs in particular — are also in principle one-time price level shocks and not ongoing inflationary ones, though the Fed would have to consider the possibility that tariffs could interact with reduced labour supply from migration and easy fiscal policy to generate more sustained inflation pressure.
In the near term there are good reasons for the Fed to stay sharply focused on inflation and employment data as it comes in. But it would be unwise for it to completely ignore obvious large potential shocks ahead.
Rather than change its baseline view now based on assumptions about who will win and what his or her policies will do, the Fed should instead consider what level of interest rates would leave it well positioned in mid-2025 for a broad range of scenarios. These should include ones dominated by Trump shocks but also those conditioned by a Harris presidency. It should then lightly pencil in a rate path consistent with this.
On current information, well positioned in mid-2025 might mean a rate in the 4 to 4.5 per cent range — significantly below the current 5.25 to 5.5 per cent rate, but still a bit restrictive.
If incoming shocks are inflationary or inflation a bit sticky, the Fed could then go on hold, and even tap the brakes with a rise at the end of 2025 if needed. If incoming shocks and data are not inflationary, it could continue cutting, or even speed up. If we pencil in two cuts under the new president in the first half of 2025, that leaves scope for two, possibly three cuts over the rest of 2024.
Of course no policy path can ever be set in stone. If the labour market were to weaken more sharply in the months ahead, the Fed would need to move aggressively. The priority would then shift to saving the soft landing and worry about possible Trump shocks later.
