Source: Zhito Finance

Currently, the Federal Reserve may need to see the impact of the series of economic policies, including import tariffs, proposed by President-elect Donald Trump before it can raise its forecasts for inflation and interest rate changes in the first half of next year.

Despite raising recent inflation expectations and citing the new government's "highly conditional estimates of policy economic impacts," the Federal Reserve lowered the benchmark federal funds rate to 4.375% last week, marking the third consecutive rate cut.

Considering the new economic realities, which may include massive spending cuts, significant changes to immigration policies, and the imposition of a series of tariffs on imported Commodities, the Federal Reserve also halved the rate cut expectations for 2025, with the market currently predicting only two rate cuts in the next 12 months.

Federal Reserve Chairman Powell told reporters last week: "The slowdown in rate cuts next year indeed reflects the higher inflation data this year, as well as expectations for rising inflation."

He said: "I think our actual cuts next year will not be due to anything we are accounting for today. We will react to the data; this is just the overall feeling that the Federal Open Market Committee thinks may be appropriate."

The uncertainty is related to Trump's tariff plans.

However, this reaction may take time to unfold, as the president-elect may not be able to impose the tariffs he has mentioned, and the responses from American trade partners have not been fully communicated.

Current legislation allows the president to impose targeted tariffs based on National Security risks, but comprehensive taxation must be approved by Congress.

According to the Pew Research Center, the Republican Party holds only five majority seats in the upcoming House, the lowest in modern history, and may lose three of those seats in the special elections in the first half of the year.

Meanwhile, imposing tariffs on Commodities from Mexico and Canada may violate the trade agreement that Trump himself negotiated in 2020 and could face lengthy legal challenges.

The same goes for spending, as the elected president proposed numerous unfunded tax cuts, and just last week, he failed to successfully pressure Congress to extend or eliminate the debt ceiling.

Patrick Welton, founder and chief investment officer of Welton Investment Partners, stated, "Investors should anticipate that tariffs will be quickly implemented in the first quarter of next year, along with slight reductions in government spending and widespread tax policy delays."

"But are tariffs long-term or just something to bring to the negotiating table?" he added.

Trump's tax and spending plans also face similar uncertainties.

Congress spending debate.

Members of the House of Representatives have passed a temporary budget agreement despite the remarks made by the elected president. They must balance the pressures from external agents, such as Elon Musk, whose task is to identify billions of dollars in expenditure from the federal budget, alongside the political need to fulfill campaign promises.

Samuel Tombs from Pantheon Macroeconomics stated: "(Last week) 34 House Republicans rejected a streamlined appropriations bill -- even after the two-year suspension of the debt ceiling was lifted -- indicating that Trump will find it hard to gather enough support for a tax cut plan that does not involve spending cuts next year."

He added: "Funding tax cuts by reducing federal employment and cutting benefit payments would harm Consumer demand."

A slowdown in Consumer demand, coupled with inflationary effects from tariffs, could not only derail the current growth trajectory of the world's largest economy but also prevent the Federal Reserve from taking decisive interest rate actions for a long time in the second half of next year.

Currently, the CME Group's FedWatch tool indicates that the likelihood of the Federal Reserve reducing interest rates in May is as likely as flipping a coin, while the possibility of a rate cut in June is only slightly higher.

Meanwhile, yields on US Treasury bonds continue to rise, with the two-year Treasury yield at 4.321%, just slightly below the current federal funds rate, even though the inflation data for November released last week came in below expectations.

Is the Federal Reserve leaning dovish on interest rates?

Gregory Daco, Chief Economist at Ernst & Young, stated: "Contrary to Powell's previous statements, the Federal Reserve does not 'guess, speculate, or assume' specific policy developments. The inflation forecast for 2025 is stronger, while the GDP and unemployment rate forecasts show no corresponding changes, indicating that some policymakers are indeed considering potential changes in regulations, immigration, Trade, and tax policy."

That said, Dakko mentioned that a more moderate outlook may emerge when the Federal Reserve revisits its interest rate forecasts in the spring.

He stated, "Despite the unusually high economic uncertainty, we emphasize that the consensus around strong growth and high inflation in early 2025 seems questionable. Given the heavy reliance on data, it would not be surprising if the Fed's interest rate cut expectations were adjusted upward in three months."

编辑/jayden