The Showdown: Trump and Powell on Economic Policy

Speaking virtually at the World Economic Forum in Davos, Switzerland, President Donald Trump indicated Thursday that he would “demand that interest rates drop immediately.” Since setting rates is the prerogative of the supposedly politically independent Federal Open Market Committee, it would be instructive to watch how the presidential demand will play out in terms of policy measures and market movements.

Federal Reserve Chairman Jerome Powell had a contentious relationship with Trump during his first administration with the President upset over the central bank not lowering interest rates sufficiently rapidly ahead of the 2020 elections. Trump wondered on X (then called Twitter) in August 2019, “Who is our bigger enemy, Jay Powell or Chairman Xi?”

Although there was speculation during the recent presidential campaign that Trump may try to remove Powell from his position before his Chairmanship ends in May 2026, the newly elected President has said that he expects the Chairman to complete his term. Powell has also said emphatically at a press conference that he will not quit even if he is asked to.

While Trump demands an immediate interest rate reduction, Fed members have been surprised by the stubbornness of inflation. Minutes of the FOMC meeting held on December 18 and 19 indicate that policymakers were concerned that the upside risk to inflation may have increased. Consequently, when the FOMC meets on Tuesday and Wednesday, it is widely expected to leave the policy rate unchanged.

And that would put the Fed and the President in direct conflict regarding what ought to be the next steps in monetary policy.

How have markets reacted to the forthcoming battle? Equities had a winning day Thursday, and another winning week, in anticipation of lower interest rates. But the prospect of lower interest rates was a damper for the dollar. The dollar weakening was also a consequence of Trump coming up with no specific tariffs on the major trading partners — China, Canada, Mexico and the European Union — in his address at Davos. Also on Thursday, Trump told Fox News “I’d rather not have to use” tariffs against China, making for a losing week for the US dollar.

The most interesting reaction, however, came from Treasurys. The bonds had rallied on market enthusiasm that the core Producer Price and Consumer Price inflation rates (which exclude food and fuel) had come down in December. The President’s demand for lower interest rates, however, led bond holders to sell their positions, fearing that a pickup in inflation would be a consequence. The yield on 10-year Treasurys rose by 5 basis points to 4.645% on Thursday, partially reversing the rally following publication of last month’s inflation numbers. Treasurys had a mini-rally yesterday when the President indicated his preference to negotiate with China rather than unilaterally impose tariffs.

The key development next week will not be the FOMC decision since it will not be a surprise. Of much greater interest would be Chairman Powell’s press conference to follow later in the Washington, DC afternoon. He is sure to be asked for his reaction to Trump’s demand for lower rates. Expect him to give the rote answer that the Fed is not a political entity and that its decision would be based solely on balancing the needs of inflation and employment. Presidential demands play no role in the Fed’s decision, he is likely to assert. (Yes, he is still selling bridges. Interested?)

But that may not stop the President from expressing his displeasure with the Fed not reducing rates next Wednesday after it had lowered them by a full percentage point between September and December. The Trump camp has suggested that the 75bp reduction in the Federal Funds rate before the November 5 elections — and, in particular, the unexpectedly large 50bp cut in September — was motivated by the central bank’s desire to assist the Kamala Harris presidential campaign.

Lack of movement in the Federal Funds rate next week would also find the President repeating that he should have a say in Fed decisions. Expect a lot of volatility in equities, bonds and the dollar between Wednesday afternoon and the Friday market close.

How will the conflict between the Fed and the President get resolved? Since Powell has said he will not resign before May next year, and since Trump agrees that Powell cannot be fired before then, expect the stalemate to continue and for markets to remain increasingly on edge.

As recently as October 9, Treasury Secretary-designate Scott Bessent had another idea — creation of a “Shadow Chair” rather than replace Powell before the end of his term. The Shadow Chair, if named, would presumably provide his or her own guidance on where rates should be headed, adding to uncertainty for investors who attempt to decide whose guidance they should follow in making decisions.

Policy disagreements are also likely to keep inflation elevated. While President Trump has suggested that he would bring down inflation by increasing US energy production and by encouraging Saudi Arabia to produce more oil, developments in the energy sector alone are unlikely to dominate over the entire inflation scene. Also, if lower energy costs put more spending power in the hands of consumers, expect inflation to pick up in other areas of spending.

Bottom line? Unless something fundamentally changes in terms of policy — emanating from Trump or the Fed — expect a relatively bearish outlook for US Treasurys.

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

srikumar@srikumarglobal.com

@SriKGlobal

January 25, 2025

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