The US Federal Reserve will most likely cut the key interest rate further on Wednesday. But stubborn inflation and questions about the independence of their institution will keep the monetary authorities busy beyond the turn of the year.
The relationship was still intact: The then US President Donald Trump appeared on November 2, 2017 with Jerome Powell, whom he had just nominated as Fed head.
Carlos Barria / Reuters
The US Federal Reserve is probably ready for the Christmas break. A turbulent year is coming to an end – thanks to high key interest rates, the Fed has finally managed to bring inflation under control – another turbulent year lies ahead for the monetary authorities.
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After taking office on January 20, President-elect Donald Trump could reignite inflation with an expansionary fiscal policy and confrontational trade policy. Perhaps he will also engage in a power struggle with Fed Chairman Jerome Powell over the “right” key interest rate and test the central bank’s institutional independence. Perhaps Trump will also concentrate on other policy areas and let Powell work in peace until his term expires in 2026. Nobody knows for sure.
Further interest rate cuts expected
Before the Fed chief and the other members of the interest rate committee disappear for the Christmas holidays and ponder these questions under the Christmas tree, they have to make their last interest rate decision of the year this Wednesday. Our colleagues in Europe presented a week ago: The European Central Bank is reducing the relevant deposit interest rate in the euro area by 0.25 percentage points to 3 percent. The Swiss National Bank even decided to reduce it by 0.5 percentage points. In Switzerland, the key interest rate is now back at a low 0.5 percent.
Most investors expect the Fed to cut interest rates by 0.25 percentage points, but also a signal from Powell that the central bank will wait to make further cuts. The members of the Fed interest rate committee will also publish their new economic forecasts. If these forecasts turn out to be more pessimistic than expected, this could also dampen the euphoria on the markets somewhat.
The American economy is still in good shape. American companies are no longer hiring as many people as last year – but they are also laying off few employees, so the labor market is in good balance. The unemployment rate has risen from 3.7 to 4.2 percent since the beginning of the year, but that’s not a bad figure.
At the same time, Powell is aware that the Fed cannot completely lose sight of inflation if it wants to prevent a yo-yo effect. Inflation has fallen sharply in the past two years thanks to strict monetary policy, but remains stubbornly above the central bank’s 2 percent target. Two important drivers of the inflation surge from 2021 will help it get closer to the target: petrol will have become cheaper in 2024 thanks to the falling oil price, and food prices have also fallen.
Housing costs in particular continue to rise, as do the prices of transport and health services. Banks should actually push down mortgage rates after the Fed lowered its key interest rates. However, it can take a very long time for this effect to have an impact on the American housing market. And of course supply and demand also determine the price of apartments and houses. They are driven by factors such as (rather high) immigration or construction activity (rather low for a long time), over which the Fed can only have an indirect influence.
Smoke signal from Mar-a-Lago
This Wednesday’s interest rate decision will be the last before Donald Trump takes office. At last month’s press conference, journalists peppered Powell with questions about the Fed’s relationship with the president-elect. Powell calmly but firmly made his position clear: the Fed would retain its independence, and he himself would not leave office early, even at Trump’s insistence.
Meanwhile, Trump nominated Scott Bessent as Treasury Secretary; his confirmation by the Senate should be a mere formality. Bessent is considered a safe value on Wall Street. The hedge fund manager has also discussed unconventional ideas in interviews; for example, that the President could nominate a “shadow head” for the Fed at an early stage, who would increasingly steal the show from Powell.
However, many on the financial market assume that there will be no showdown between Trump and Powell in 2025. On the one hand, the Fed is currently lowering key interest rates anyway and is therefore behaving in a way that would probably please President Trump. On the other hand, the Republican government’s policies, even if they are unsustainable, are unlikely to increase inflation directly.
