Be cautious! The road to rate cuts by the Federal Reserve is bound to be bumpy

The Federal Reserve seems to finally believe that it has brought the persistently high inflation under control over the past three years. However, the two current US presidential candidates may once again trigger inflation.

Of course, both Republican Trump and Democrat Harris have not openly called for raising inflation, but they have proposed key policies that could lead to inflation.

Analysts at investment firm Raymond James wrote in a recent research report, "Trump's policies on trade, tariffs, taxes, and immigration could exacerbate concerns about inflation. As for Harris's plans, historically, housing subsidies and price caps have led to unforeseen consequences, intensifying market concerns about inflation."

Each policy of Trump and Harris is designed to win over specific voter groups and address their specific concerns. However, what they have not told voters is that if these plans are fully implemented, they may have some unpleasant adverse consequences.

For example, Trump wants to impose a 20% tariff on most imported goods. Trump's idea is to make foreign goods more expensive, so that domestic producers will have a stronger cost competitiveness and sell more products in the US.

However, this taxation on goods actually results in price increases, mainly borne by American consumers. According to data from the Peterson Institute for International Economics, the additional cost for a typical household is about $2,600 per year. This $2,600 annual loss far exceeds the losses that food inflation has brought to shoppers over the past three years.

Trump also vows to "massively deport immigrants," deporting millions of undocumented immigrants. This caters to voters who believe that immigrants are taking away American job opportunities and bringing other problems. However, most immigrants are working, and expelling a large number of immigrants will reduce the labor supply.

A reduction in labor supply will push up labor costs, ultimately benefiting higher-income workers. However, companies typically pass on higher labor costs to consumers by raising prices, which is one of the reasons for the soaring US inflation over the past three years. Trump's deportation plan will lead to a significant increase in labor costs once again.

Harris's plan will result in a different type of inflation. Harris focuses on food and housing costs, two issues that have been particularly troublesome during the Biden administration. Her food plan will focus on how to prevent "price gouging," which is excessive price increases beyond the producer's own cost increases.

However, many economists point out that government efforts to control prices often backfire because producers who cannot raise prices will restrict supply to protect profit margins. When supply decreases and prices are capped, the typical result is shortages. This is not strictly inflation, but it is likely to anger consumers just the same.

As for housing, Harris proposes to provide $25,000 in "down payment assistance" for first-time homebuyers. Whether in the form of grants or loans, there is ample evidence that government subsidies will push up costs as they stimulate demand.

For example, student loan subsidies have already driven up college tuition fees. The US government's stimulus payments during the pandemic have provided millions of Americans with free spending money and fueled post-pandemic inflation Housing subsidies are almost certain to have the same effect by increasing buyers and stimulating demand for limited housing supply.

The Oxford Economics estimates that by 2028, Trump's policies will lead to inflation about 0.3 percentage points higher than under other circumstances. Harris's policies will result in inflation about 0.2 percentage points higher, and house prices will be about 0.5 percentage points higher than under other circumstances.

While these numbers may seem small, they carry significant implications. If the Federal Reserve detects new inflationary pressures, it is likely to reverse the rate cut policy announced by Fed Chairman Powell on August 23rd.

Powell is now hinting at gradual rate cuts over the next few years. However, he also made it clear that if inflation resurges, the Fed may pause rate cuts or even begin raising rates again.

A key premise of many of Trump's and Harris's policies is that they require congressional action to be implemented, which is unlikely to happen unless the next president's party gains full control of Congress. Currently, a divided Congress remains the most likely election outcome, which would stifle partisan legislation needed for new homebuyer subsidies, tax breaks, and many other matters.

However, Trump can still raise tariffs and deport immigrants without congressional action. Therefore, if he wins, the real question may be whether he will fulfill all his promises.

Currently, investors are optimistic about the upcoming Fed rate cuts, which typically benefit corporate profits and stock values. If the U.S. presidential election changes this outlook, the market may once again fall into turmoil