Fed Should Pause Rate Cuts Until Trump’s Plans Become Clearer
By James Picerno | The Milwaukee Company | jpicerno@themilwaukeecompany.com
Donald Trump’s election victory appears to have altered the assumptions about what’s prudent for monetary policy in the near term. The continuity in fiscal policy that would have likely prevailed if Kamala Harris won has given way to a high degree of uncertainty about how a Trump administration will govern with respect to key policy preferences outlined on the campaign trail.
Although the general outline of the president-elect’s agenda are well known, there’s debate about the details and, more importantly, how hard he’ll push on his policy positions re: taxes, tariffs, immigration and other macro topics. What is clear is that with Republicans in control of the White House, Senate and (potentially) the House, the GOP has something approaching carte blanche for reshaping policy to the liking of the 47th president.
The uncertainty, in sum, is about the degree of change that will unfold in 2025. Many economists predict that the changes favored by Trump will tilt the economy toward a reflationary bias, which is to say reverse the disinflationary bias that’s prevailed in recent history. The potential for a re-acceleration in pricing pressure, combined with an economy that remains on a growth trajectory, raises questions about the wisdom of two more rate cuts ahead of Trump’s inauguration in January. Fed funds futures at the moment are pricing in high odds that the central bank will reduce its target rate by a ¼ point tomorrow (November 7) and do so again at the December policy meeting.
Going into the election, there was a case for continuing to dial down the still-hawkish monetary bias. The TMC Fed Funds Model, which uses five factors (inflation, unemployment, real 10-year yield, GDP and the yield curve) to nowcast a prudent fed funds rate, continues to recommend reducing the current 4.75%-5.0% target range by more than a full percentage point. Closing the spread gradually over several months would be a reasonable plan absent what could be a radical shift in fiscal policy in 2025. But the model is backward-looking based on hard data. Normally that’s a reasonable bias and framework because fiscal policy doesn’t usually radically change in the short term. But given the potential for a dramatic shift in the government’s agenda, ex ante risk for our model has spiked. As a result, the wisdom of pushing ahead with back-to-back rate cuts before the new administration and Congress take office is hasty.
The reasoning for our view centers on the possibility that a new round of reflation may be brewing. That’s partly a reflection of Trump’s inflationary policy preferences -- imposing hefty tariffs on imports and reducing the labor force by deporting millions of immigrants.
The bond market seems to agree that reflation risk is rising. Notably, the US 10-year Treasury yield, after trending higher for the month heading into the election, jumped sharply today (the first trading day after Trump’s win). As of this writing, the 10-year yield is 4.44%, the highest in four months.
Note, too, that broadly defined money supply (M2) in real terms is rising again after 2-1/2 years of contracting. The shift suggests that the policy bias is once more inflationary, albeit trivially so through September. But with the Fed poised to continue easing policy further, the central bank may find itself in an awkward position in next year’s first half if fiscal policy changes create a stronger tailwind for reflation.
The case for continuing rate cuts would be stronger if the economy was weak and unemployment was rising. But the jobless rate was unchanged at a low 4.1% in October and economic growth posted a solid 2.8% annualized increase in the third quarter. With the economy still humming, and the potential for a stronger reflationary bias next year, the Fed has room to put rate cuts on hold until fiscal policy changes and the related impact on the economy become clearer.