This week’s U.S. Federal Reserve meeting will begin to raise expectations for President Donald Trump’s next nominee to lead the central bank, potentially leaving policymakers in a difficult situation between widely shared inflation concerns and Trump’s demands to cut interest rates.
A quarter-percentage-point cut seems like a given at the two-day meeting that ends Wednesday, but the language around that decision and the economic projections that accompany it will show whether the next president will take control of an agency prepared to resist further cuts or more open to debate and with a more moderate near-term outlook.
Trump is seeking lower borrowing costs, particularly to boost the housing sector, as a way to address broader concerns about affordability, which could be crucial for the midterm elections. Delivering on this, however, could pose risks for the next Fed chair, as analysts expect resilient growth next year, sustained consumer spending thanks to higher tax refunds and, as a result, more persistent inflation.
“Regardless of who leads the Fed, monetary policy is determined, first and foremost, by economic conditions,” said James Engelhof, chief US economist at BNP Paribas, during a conference call on economic outlook for 2026. Engelhof anticipates resilient growth and persistent inflation of 3%, which will result in a single rate cut next year, following the one expected on Wednesday. “The data will suggest little need for aggressive rate cuts.”
This could put the next Fed chair in the same situation as Jerome Powell: pressured by Trump to cut rates in an economy that needs moderation more than stimulus. Since the midterm elections could hinge on affordability and labor market issues, pressure on the Fed could increase and trade-offs could intensify.
Cutting rates too much could boost demand, boost hiring, and make mortgages more affordable, while raising inflation and ultimately shifting public expectations in a way that makes it harder for the Fed to meet its 2% inflation target, an outcome that current policymakers have vowed to avoid.
The decision on the least risky path has already divided the Fed, leaving the possibility of multiple dissents to this week’s rate decision. Policymakers’ new projections for rates, inflation and unemployment for next year, to be released alongside the statement, could show how likely these divisions will remain during the leadership transition.
In September, policymakers, on average, expected just a quarter-percentage-point cut in 2026, with the Fed rate ending next year in the 3.25 to 3.50% range, possibly still slightly slowing the economy.
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Projections in the dark
Powell’s term as president ends in May. Trump said he will nominate a successor early next year, with a confirmation vote to follow in the Senate.
This week’s projections will be hampered by the 43-day government shutdown during October and November. The most recent government reports on the labor market and inflation are for September, allowing policymakers to fill in gaps with private estimates, their own surveys and conversations with business and community contacts.
Data scheduled after the Fed meeting could help clarify whether the economy is leaning toward lower employment or higher inflation, and thus help narrow the policy gap. However, they could also prolong the current stagnation if, as analysts predict, the unemployment rate remains relatively low and inflation remains above target.
A recent Reuters poll of economists anticipates economic growth in 2026 of around 2%, slightly above most trend rate estimates, with underlying inflation considerably higher than the Fed’s target of 2.8%, and an average unemployment rate of 4.4%, similar to September.
That would come as little relief to Fed officials, particularly a group of regional reserve bank presidents, who say they want to make sure inflation — above target for nearly five years — declines before lowering interest rates further.
Tim Duy, chief US economist at SGH Macro Advisors, said he expects a drastic cut from the Fed this week, after a controversial battle.
After that, “official interest rates will be close enough to neutrality so that the margin for further cuts increases,” Duy said, referring to the fact that the interest rate is not considered a factor that encourages or discourages economic activity, and therefore, neither drives nor stops inflation.
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Risk of a return
Determining the neutral rate, already notoriously difficult, could be even more complicated now that the economy is still grappling with tariff hikes, immigration restrictions and other Trump policies that challenge analysts already trying to assess a possible negative impact on labor and productivity from the rise of artificial intelligence.
Additionally, Trump-appointed members of the Fed Board of Governors outlined various arguments for continuing the cuts, with Governor Stephen Miran arguing that rates should be slashed to a level that most of his colleagues would consider aggressively stimulative.
Meanwhile, Kevin Hassett, Trump’s economic adviser and a leading candidate to succeed Powell, talks of a productivity boom fueled by artificial intelligence, which, if developed, could reduce inflation risks and allow for lower rates even as economic growth accelerates.
This is part of a broader push for a more Trump-aligned and dovish Fed, including Trump’s attempt to fire Governor Lisa Cook, an appointee of former President Joe Biden, and Treasury Secretary Scott Bessent’s recent comments about possible changes in the hiring of reserve bank presidents, a potential pressure point for a group that, for now, is leaning more toward a more restrictive stance.
How much all of this will translate into monetary policy remains to be seen, especially if the economy remains broadly on track and inflation persists. If the Fed, under a new chairman, tries to lower rates too quickly, it could backfire, said Nathan Sheets, global chief economist at Citigroup.
“If the Fed goes ahead and cuts interest rates more aggressively than the markets think is justified, the markets will say it’s inflationary” and will raise long-term rates, including mortgage rates, even if the Fed is lowering the short-term rate, Sheets said. “If you elect a Fed chair who is more closely connected to the administration and wants to give the president a strong economy for the midterm elections, the way to do that is not for the back end of the yield curve to shoot up… That’s going to strangle the housing market.”
With information from Reuters
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