Former member of the New York Fed's Board of Governors and Vice Chairman of Evercore ISI, Krishna Guha, stated that the U.S. election has put the Federal Reserve in a dilemma, and the current economic forecast summary of the Fed is actually a "constrained Harris election prospect," while Trump is a disruptor. Here are his views.

Investors are struggling to understand what Trump's potential re-election means for the U.S. economy, the Federal Reserve, and interest rates, while also weighing the potential for Vice President Harris to turn things around.

Trump urged the Federal Reserve not to cut interest rates too quickly when inflation is still high, which many interpreted as meaning that cutting interest rates before the November election makes no sense. Although this will not prevent the Fed from cutting interest rates in September, it is more important for the Fed to carefully explain its reasons, which is one of the reasons why this week's meeting is unlikely to result in an early rate cut.

Most investors assume that once Trump is elected, he will pressure the Fed to cut interest rates. The intense "verbal intervention" seems possible, although the direct attack on the Fed's independence proposed by some of Trump's advisers is unlikely to materialize, and if it does, it could be quickly stopped by the surge in bond yields and the selling of U.S. stocks.

Any political pressure will make it more difficult for the Fed to maintain credibility while cutting interest rates. Fed Chairman Powell may keep a low profile, focus on his own work, and rely on Congress to provide protection from the executive branch. But the Fed still needs to consider the potential impact of Trump's policies.

The Fed's current economic forecast summary is actually a "constrained Harris election prospect." This is because the forecast assumes no new shocks, which is likely to occur if Harris wins but is limited by a Republican-controlled Senate. But Trump is a disruptor. The change in market prices suggests that investors believe that Trump's trade, immigration, fiscal, energy, and deregulation policies generally have a re-inflationary effect and will push nominal GDP and inflation higher.

This poses a dilemma for the Fed: should it update its policy plans early based on expected shocks, or wait and risk falling behind the changing situation? It seems likely to make mistakes in the direction of slow adaptation to potential shocks, that is, to update its benchmark forecast after the election and then act cautiously.

The Fed does not know who will win the election, nor does it have an advantage in judging which policies will be implemented, and it will be very clear about the difficulty of simulating potential effects. It will not want to predict Trump's inflationary policies during the campaign. Fortunately, bond yields are sharing some of the work, and when the chances of Trump winning rise, bond yields will also rise, which will help prevent the economy from overheating.

Although the Fed must consider the potential for increased tariffs, reduced immigration leading to a decrease in labor supply, and the possibility that loose fiscal policy will create more persistent inflation pressure, some of Trump's impacts, especially tariffs, are actually one-time price level shocks rather than sustained inflationary pressures.

In the short term, the Fed has good reason to closely watch upcoming inflation and employment data. But it would be unwise for it to completely ignore the apparent potential major shocks.

The Fed should not change its benchmark views based on who is expected to win the election, but should consider which interest rate level would position it favorably for a variety of situations in mid-2025. These situations should include the potential shocks led by Trump and those led by Harris as a constrained president. Then, it should gently sketch an interest rate path consistent with this.

Based on current information, being in a good position in mid-2025 may mean an interest rate range of 4% to 4.5%, significantly lower than the current range of 5.25% to 5.5%, but still somewhat restrictive.

If the shock is inflationary or if inflation is somewhat sticky, the Fed can pause and even raise interest rates by the end of 2025 if necessary to brake. If the shocks and data are not inflationary, it can continue to cut interest rates, even at a faster pace. If we expect two rate cuts in the first half of 2025, that leaves room for two more, and possibly three, in the remaining time of 2024.

Of course, no policy path can remain unchanged. If the labor market significantly deteriorates in the coming months, the Fed needs to take decisive action. The focus will then shift to ensuring a soft landing and later worrying about possible Trump shocks.