Tomorrow marks the first Federal Reserve meeting since Donald Trump's inauguration. Analysts generally expect the Fed to keep interest rates unchanged at 4.25%-4.50%. Markets, including the S&P 500, also anticipate a pause in monetary policy easing until June of this year.
But why pause monetary easing when core inflation (CPI) is slowing? In December, for example, it stood at 0.2%, down from 0.3% in November and below expectations of 0.3%. The answer lies in the outlook or, more precisely, in the growing risks that the disinflation trend will reverse in the coming months.
For prices to continue to fall, one of two things has to happen: either the supply of goods, services, and labor will increase, or demand will fall. Unfortunately, neither scenario seems likely in the near term under Trump's policies. In fact, it is far more likely that both will move in the opposite direction.
Starting with supply, trade wars — particularly with China, Canada, and Mexico, which account for over 40% of U.S. imports — are unlikely to increase the flow of goods into the country. Switching to domestically produced goods isn’t a straightforward alternative either, as they are typically more expensive.
Even if U.S. producers were inclined to lower prices, labor shortages would present another hurdle. Immigration crackdowns targeting undocumented workers could reduce workforce availability, further tightening supply. In short, there’s little reason to expect supply-side pressures to ease prices anytime soon.
On the demand side, the picture isn’t much better for disinflation. The U.S. economy remains strong:
- The S&P Global Flash U.S. PMI business activity index rose from 54.9 in November to 55.4 in December.
- GDP growth for Q3 was revised upward, from 2.8% to 3.1%.
If implemented, Trump’s proposed policies, such as cutting corporate taxes to 15% and eliminating income tax, could further boost economic growth. While this might mirror the Reagan-era boom, it’s more likely to fuel inflation than curb it. It’ll be interesting to see if Powell mentions this in his press conference.
Some suggest falling energy prices could help offset inflationary pressures, but this is doubtful. Trump's executive orders, such as lifting drilling restrictions, are unlikely to yield immediate results. Moreover, U.S. oil companies have little interest in prices falling too much, as it would reduce their profits.
The bottom line is that the risks of another pickup in inflation, at least for now, outweigh the chances of further price declines. As a result, the Fed is likely to keep rates unchanged despite pressure from the 47th chairman to act otherwise. As for the markets' reaction, they have already discounted this scenario.
Looking ahead, the Fed's decisions will, or at least should, depend on the data. For the time being, the January Global Fund Manager Survey shows that 79% of investors expect the Fed to cut rates in 2025, while only 2% expect hikes. A shift to a moderate stance could weaken the dollar and boost stocks.