The potential for conflict between the policies of the incoming Donald Trump administration and the Federal Reserve's price stability mandate has been a topic of discussion since before the election. We've known for a long time — in broad, hazy outline — what the new president's policy ambitions are. Low taxes, low immigration, high tariffs, a small current account deficit. Yesterday came the first indications - again, broad and vague - of what the central bank's response might be.
The Open Market Committee cut its policy rate by a quarter point, as expected. But the friction was not in their actions, but in their expectations. The Summary of Economic Estimates, last seen in pre-election September, showed a 50 basis point increase in the expected policy rate for the end of next year. It now stands at 3.9 percent, slightly more than two rate cuts from where we stand today. Inflation expectations for 2025 rose 40 basis points to 2.5 percent. More importantly, perhaps, the Committee's uncertainty about inflation has increased dramatically. The range of members' 2025 inflation projections, from lowest to highest, was 30 basis points in September. Now it is 80.
A natural question to face with this shift is how much the election changed the committee's outlook. Several journalists questioned, focusing on the inflationary impact of the tariffs. Powell's response, somewhat disappointing, was twofold. First he said:
That is not the question before us at this time. We don't know when we will face this question. What the committee is currently doing is discussing the ways and understanding the ways in which tariffs can increase inflation in the economy. . . That puts us in [a] The situation, when we look at what the actual policies are, requires a more careful, thoughtful assessment of what the right policy response might be.
It seems sensible. Then he said this:
some people [on the committee] took a very early step and began to include highly conditional estimates of the policy's economic effects in its forecasts and said so at the meeting. Some people said they didn't, and some people didn't say whether they did or not...
Some identified policy uncertainty [as a reason] To write off more uncertainty about inflation. And the point about uncertainty is that it's kind of common sense that when the path is more uncertain you slow down a bit. It's not unlike driving on a foggy night or walking through a dark room full of furniture.
In the letter, both statements are consistent. Together they say that while likely Trump policies did not enter the rate decision, they did enter the SEP. In spirit, however, they are inconsistent, because in central banking, expectations are policy. This was seen in the market reaction yesterday. Facing a Fed that is worried about Trump's inflation, and consequently thinking more dovishly, the S&P 500 fell 3 percent, the two-year bond rose 14 basis points, and the 10-year bond rose 10 basis points. Small-cap stocks, darlings of the Trump trade, fell hard and have now given up all their post-election gains:
Have Fed members made a mistake in thinking they know what Trump's policies will be, and how they will affect rate moves? And in doing so, did they show some political bias? On both fronts, I'd say they probably have. Everyone seems to think they know what the second Trump administration will do. But the president's unflappable leadership style, his diverse cabinet choices, and his party's narrow margin of control in both houses of Congress mean that it would be foolish to rely on this topic. Arguments that tariffs and immigration policy can lead to persistent inflation are a bit shaky, raise an overconfidence problem, and smack of motivated reasoning.
Before condemning Powell and his colleagues, however, remember three things.
One: The committee also had good non-political reasons for raising its inflation expectations. The last two consumer price index are inflation readings DisappointingAnd growth has been hotter than expected. Indeed, many pundits have argued that today's cut was a mistake (imagine the market reaction if the committee had stood down!) A rewrite of 2025 expectations was already in order; Do not exaggerate the political aspect.
Second: Any plan avoids contact with the enemy. We are still in the realm of expectations. Trump's fiscal policy and the Fed has not engaged in a real battle between monetary policy, and when it is, the picture will change. It doesn't have to be bloody. Chair Paul Volcker and President Ronald Reagan had a spirited battle in the 1980s, and the country was just fine.
Finally: Don't read too much into the market's reaction. Stock valuations are historically high and the bull market is long overdue. Expectations are that the Fed will cut rates next year. In this environment, rate expectations will not rise much enough to whip the stock market. This is something that both Trump and Powell will have to keep in mind.
Cars and 2025
We promised that our 2025 predictions would come out today, but with the Federal Reserve meeting concluding tomorrow, they will have to wait. However, we got a lot of responses on people's favorite cars. They showed that unheaded readers are a different bunch. One reader simply emailed “Ferrari 286 GTB”; Another spoke fondly of the 2008 Toyota Rav4. Some keep it going with electric cars from Tesla and BMW; Others went old school with a Volkswagen T4 camper van or the now defunct Lancia Kappa. The automobile industry is struggling, but people sure love their cars. Email us with the worst you've ever owned: robert.armstrong@ft.com And aiden.reiter@ft.com.
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