The Federal Reserve may enter a prolonged pause in interest rate cuts! The earliest will be next year

Trump has confirmed his victory in the presidential election, although it is still uncertain who will ultimately control the House of Representatives, and the official results may be delayed. However, due to Trump's strong performance in the popular vote, Nomura Securities analysts believe that the Republican Party is likely to win the House. This means that a so-called "red wave" is expected.

In the short term, Nomura Securities believes that tariffs and inflation in the United States will rise. The firm expects Trump to fulfill his campaign promises by raising tariffs, which will push up U.S. inflation in the short term and slightly dampen economic growth. During the inflation surge triggered by tariffs, the firm anticipates that the Federal Reserve will pause its rate-cutting cycle. Although Nomura still expects two more 25 basis point rate cuts this year, it now predicts only one rate cut in 2025 and two more in 2026, raising its terminal rate forecast by 50 basis points to 3.625%.

Trump's Policies Will Weigh on the Economy and Push Up Inflation

Trump's economic policies are expected to focus on increasing tariffs and extending the expiration provisions of the Tax Cuts and Jobs Act of 2017. Trump has the authority to implement tariffs without congressional approval, and Nomura Securities expects trade restrictions to be swiftly introduced after Trump takes office. According to its baseline assumption, the average tariff rate is expected to gradually rise to 11-12% by mid-2026 (currently at 2.5-3.0%).

Compared to 2018-2019, Nomura Securities expects the global tariff measures of the Trump 2.0 administration to exert greater upward pressure on U.S. inflation, as this time the tariff coverage will be broader, affecting more everyday consumer goods. The expanded scope of tariffs will also make it more difficult for importers to substitute between suppliers. Additionally, the prices of domestic goods may rise in tandem with the prices of imported goods.

As a result, the firm has raised its inflation expectations for 2025 and 2026 to an average of 3.1% and 2.7% (previously 2.3% and 2.1%, respectively). Although the specific timing of the tariffs is still uncertain, inflationary pressures are expected to emerge starting in the second quarter of 2025.

Nomura Securities also pointed out that the increase in tariffs could lead to stagflation effects, suppressing personal consumption and business investment. The costs of tariffs are typically borne by U.S. residents rather than foreign exporters. In addition to this direct "tax burden" impact, the uncertainty surrounding the scale and duration of tariffs, as well as potential negotiations or retaliations from trade partners, will put pressure on business investment.

In terms of tax policy, Nomura believes that if a "red wave" does occur, Trump will easily extend the expiring tax cuts in 2025. Although Trump proposed several other tax cuts during the 2024 campaign, the firm believes that ordinary Republican lawmakers may not support some of the larger proposals, such as additional corporate tax cuts or exempting tips and Social Security income from taxation. Extending current tax policies is expected to widen the deficit, but its stimulative effect on economic growth and inflation is limited

The Federal Reserve's Response: Pausing Rate Cuts, Focusing on Inflation

U.S. inflation has exceeded the Federal Reserve's target for four consecutive years, therefore, Nomura Securities believes that the Federal Reserve will not easily overlook the inflation rise caused by tariffs.

Although the firm expects the impact of tariffs to be temporary, there are still spillover risks from inflation expectations, wage increases, or rising prices of domestic goods and services. In its baseline assumption, the Federal Open Market Committee (FOMC) will pause the easing cycle when inflation accelerates, and will only resume rate cuts once it confirms that inflation has returned to normal. Theoretically, there are reasons to pause rate cuts even before the rise in tariffs. However, the firm expects the Federal Reserve to strive to appear politically neutral, preferring to respond to data rather than appearing to tighten due to Trump’s policies.

Nomura points out that the specific arrangements of Federal Reserve policy will depend on the timeline of tariffs. Currently, it still expects two more rate cuts this year, only one in 2025, after which it will enter a long pause phase, with a 50 basis point cut in mid-2026, and the terminal rate expectation raised from the previous 3.125% to 3.625%.

Additionally, global tariff increases may bring a large amount of front-loaded revenue, thereby offsetting some of the early deficit impacts from tax cuts. However, Nomura believes that tariffs are detrimental to the fiscal outlook in the long term, and the damage to economic growth is more significant, with the uncertainty exacerbating this direct fiscal drag