Federal Reserve poised to cut interest rates under shadow of Trump's presidential victory

Federal Reserve Chairman Jerome Powell has said the central bank remains insulated from politics. AP

The Federal Reserve is poised to cut US interest rates for a second consecutive time on Thursday, as the victory of President-elect Donald Trump casts a cloud of uncertainty over America's economic outlook.

Markets have virtually locked in a rate cut of 25 basis points, according to the CME Group's FedWatch tool. That would make this week's decision to lower its target range to 4.50 per cent to 4.75 per cent a duller affair than when it began its easing cycle with a jumbo rate cut in September.

Instead, attention will likely turn to how Mr Trump's stunning presidential victory could alter the Fed's outlook. Fed Chair Jerome Powell will address reporters shortly after the central bank announces its policy decision.

He spent much of his campaign touting an across-the-board tariffs policy to replace the income tax system. Should Mr Trump follow through on his policies with a Republican-held Congress, economists warn it could reignite inflation and force the Fed to raise rates again.

The 10-year Treasury yield surged to about 4.45 per cent as traders anticipated Mr Trump's win. “We continue to regard the Trump sweep scenario as most meaningful in terms of economic policy impact,” David Meier, economist for Julius Baer, wrote to clients.

The US economy dominated political discourse this election cycle, with inflation consistently polling as one of the top issues for US voters still reeling from a global inflationary surge in 2022. The discourse seeped into the decisions of the Fed, which batted away notions that its actions would be influenced by politics. Mr Trump also claimed the Fed's September rate cut was a political manoeuvre to boost the Democrats' electoral chances.

Underlining this quagmire for the Fed is its schedule this week. The central bank moved its decision to fall on a Thursday to avoid overlap with election day.

Mr Powell has largely insulated the Fed from Washington politics, shrugging off claims made by Democratic and Republican politicians this year as to how long to hold rates. While he is set to be grilled by reporters on how the outcome of the election will impact the Fed, the chairman will probably stick to his independent and data-dependent approach.

Future rate path unclear

The Fed is cutting rates to achieve a so-called soft landing, whereby the central bank tames inflation without causing an economic downturn. September's inflation was at 2.4 per cent, not far off from the Fed's 2 per cent target and well below its 9.1 per cent peak in 2022.

That has allowed Mr Powell to adopt what he called “a recalibration” to adjust rates with inflation falling. Fed officials are now moving to shore up the labour market – the other side of its dual mandate. Even after last week's strange jobs report that was affected by a Boeing machinist strike and two hurricanes, the unemployment rate is at a still low 4.1 per cent.

Mr Powell and his Federal Open Market Committee (FOMC) colleagues have called for a gradual approach to reducing monetary policy, and projections released by the Fed in September showed they expect to cut rates by 25 basis points in December as well. Beyond that, however, is less clear.

“For me, the central question is how much and how fast to reduce the target for the federal funds rate, which I believe is currently set at a restrictive level,” Fed Governor Christopher Waller, an influential member on the FOMC, said last month.

The Fed currently assesses the neutral rate – the level of rates that neither contract nor expand the economy – to be at 2.9 per cent. Still, that is only the Fed's best guess at what the neutral rate is, as no one knows the true figure (a fact Mr Powell and his colleagues have acknowledged).

“Really, the big debate at this point is, what level do they go down to before they say, 'OK, we've cut rates enough'. So I think the press conference will be important if Powell gives us any clues as to what they're thinking about where the neutral rate is,” Tim Murray, capital market strategist at T Rowe Price, said last week.