A recent article in The Economist discusses the following assumptions about the next president’s views on interest rates:
Conversely, the Fed’s hawkish stance could anger Trump, who has insisted that as president he should have a say in interest rates. He will likely want to cut interest rates even further once he takes office.
This reminds me of a story titled “The Monkey’s Paw” where the main character is granted three wishes, but they don’t work out as intended. Let’s consider some possible outcomes and then assess the type of interest rate path Donald Trump would prefer.
1. Significant interest rate cuts are almost always associated with economic recessions. Recent examples occurred in 2020, 2008, and 2001. Recessions are unpopular.
2. Some may argue that The Economist means President Trump wants a strong economy and a sharp drop in interest rates. And the economy is looking pretty strong right now, with the Atlanta Fed forecasting growth of 3.3% in the fourth quarter. However, there is a significant risk that a significant rate cut under this scenario could lead to high inflation. Currently, the federal funds futures market is predicting some rate cuts in the coming months, but not as much as in recent months. At the same time, market inflation expectations are slightly above target. If the Fed were to adopt even more “significant rate cuts” than recently, despite strong NGDP growth, there would be a very real risk that inflation would accelerate again. Inflation is unpopular.
3. The Fed’s interest rate target is probably still well above equilibrium. (But then why is growth so strong?) Perhaps it is possible to cut interest rates and keep the economy expanding, as we saw in 2019 and 1998. But we’ve already seen a 75 basis point rate cut. It would be almost unprecedented for banks to cut rates even further without addressing a flare-up in inflation or a recession.
To be clear, I am not saying that a recession or high inflation is likely. But that’s because they don’t expect further significant rate cuts. I expect the pace of rate cuts to actually slow in 2025. And we believe this will be the best possible outcome. Certainly I would go further. If these three scenarios had been fully explained to President Trump, he would not have supported “further rate cuts,” especially if he had recently read The Monkey’s Paw.
Or Goldilocks and the Three Bears.
This is an illustration of “The Monkey’s Paw”.
