"Arch-rivals" are at it again? Trump may disrupt the Fed's plans

If Trump returns to the White House, the struggle of the Federal Reserve to control inflation may face new challenges, a dynamic that could make the Federal Reserve once again a "thorn in the side" of this former Republican president.

Many economists believe that Trump's tariff agenda, coupled with the goal of deporting millions of undocumented workers and the possibility of expanding the deficit, will reignite the price pressures that are currently easing and may prompt the Federal Reserve to adopt a more stringent monetary policy than it is now.

Forecasters point out that Trump's plan to impose a 10% tariff on imported goods will cause a one-time surge in inflation, while deporting workers will push up the wages of remaining workers, thereby increasing pressure.

For example, a model from Oxford Economics, a research institute, predicts that during Trump's second term, the peak of the inflation index closely monitored by the Federal Reserve, excluding food and energy prices, will be 0.3 to 0.6 percentage points higher than expected under current appropriations and policies.

In contrast, if a Democratic government led by Vice President Harris takes office, the potential increase in inflation will be between 0.1 and 0.2 percentage points. Oxford Economics and other institutions believe that Harris will largely continue Biden's economic policies.

Differences between the Trump and Harris Administrations

With the Federal Reserve actively raising interest rates, the highest inflation rate in a generation is currently falling below the 2% target. The market expects the Federal Reserve to cut rates in September, followed by more rate cuts. But Trump may disrupt this plan.

Mark Sobel, Chairman of the Official Monetary and Financial Institutions Forum US Branch and former official at the US Treasury under Democratic and Republican presidents, said, "Trump's economic plan is essentially inflationary. Substantially raising tariffs, expansionary fiscal policy, and massive deportations of immigrants, all of these factors combined will result in higher inflation and interest rates than before."

Diane Swonk, Chief Economist at KPMG, also stated in a briefing that Trump's tariff hikes coupled with "substantial" restrictions on foreign labor mean that inflation is "coming back", which is likely to force the Federal Reserve to keep rates at the current level for a "longer period".

Oscar Munoz, Chief US Macro Strategist at TD Securities, said that Biden and Harris' trade policies "still differ significantly from Trump's tariff policies".

In contrast, he said, under the "surgical" trade actions expected by the Harris administration, "we expect these policies not to pose a meaningful risk to our inflation/economic growth forecasts".

Analysts at Evercore ISI believe that if Trump wins, the Federal Reserve's response to the new outlook will be slower than the market. However, they stated that if Trump wins, policymakers may scale back some of next year's rate cuts and may even raise rates by the end of 2025 When asked how Trump's policy agenda contradicts economists' expectations of rising inflation, Karoline Leavitt, the national press secretary of the Trump campaign team, argued: "The American people don't need economists to tell them which president will put more money in their pockets. When President Trump returns to the White House, he will re-implement his agenda supporting growth, energy, and employment to reduce the cost of living and improve the standard of living for all Americans."

The Fed needs to react to changes in the outlook

It is unclear how the Fed will consider the impact of a Trump victory, but at least one former Fed official believes that the Fed needs to start considering the impact of a Trump victory, even when considering recent rate cuts.

Former Boston Fed President Eric Rosengren wrote on social media this month: "If the possibility of Trump winning looks significant, the Fed needs to consider whether it is reasonable to cut rates based on current data, given that potential fiscal actions in the future could lead to the need for the Fed to reverse policy to address inflationary shocks. This is not about politicizing policy, but about reacting to forecast changes."

Richmond Fed President Thomas Barkin issued a warning. He told reporters last week, "It is difficult to formulate policy now because people have expectations about future government actions."

Meanwhile, Fed Chairman Powell earlier this month declined to comment on the impact of any future policy changes such as expanding tariffs in Congress.

The transition of inflation will be slow

Jason Furman, former Chairman of the Council of Economic Advisers under the Obama administration and current economics professor at Harvard University, said that the transition of inflation will be a slow process.

He said: "We are not talking about a 5% or 6% inflation rate, but (in the case of a Trump victory) the inflation rate will be higher than in other scenarios, and monetary policy will be tighter."

As for how a victorious Trump will respond to Fed rate cuts or even reverse any easing measures, that remains another unknown.

There have been widely publicized conflicts between Trump and Powell during his term, despite Trump appointing Powell as Fed Chairman. However, Trump recently told Bloomberg that he will not try to oust Powell before his term ends in 2026.

Barry Eichengreen, economics and political science professor at the University of California, Berkeley, said at an event in Peru last Friday that if the Fed resists Trump's policies, Trump may try to reshape the Fed.

Eichengreen said: "By May 2026, Trump will have a more direct choice, which is to nominate a more compliant Fed Chairman, one who will not take action to counter rising inflationary pressures but instead exacerbate them. In this scenario, investors may significantly increase the costs of the Federal Reserve's heavy-handed actions.

Scott Lincicome, a trade policy expert at the Cato Institute, said, "Even attempts to weaken the Fed's independence could at least trigger some market reactions," which may prompt elected officials to reconsider such actions