The Fed cuts its key interest rate by a quarter point, but signals ongoing inflation concerns

The Federal Reserve said Thursday it would cut its key interest rate by a quarter point, a widely expected move that coincides with inflation moving closer to the central bank's 2 percent target.

In their statement, Fed officials noted that inflation remained “somewhat elevated” while unemployment “increased but remains low.” However, they noted that labor market conditions have “generally eased” – perhaps pointing to signs of increasing weakness in hiring.

Some market participants noted that officials had removed key language that had previously suggested they remained confident of meeting the 2% inflation target.

In a note to clients, Omair Sharif, president of Inflation Insights, said this could signal a new willingness by the Fed to forego a widely expected additional quarter-point rate cut next month.

“If that is the case, the committee is more likely to face a recess.

In other words, the central bank would keep interest rates elevated.

With the pain of four years of rapid price growth still lingering, there are now concerns that President-elect Donald Trump's economic plan, particularly his tariff proposal, could trigger a new inflationary environment.

On Wednesday, Wall Street traders were almost unanimous that the Fed would cut the federal funds rate, which serves as a benchmark for other borrowing rates in the economy, by a quarter point. The central bank is trying to scale back the restrictive lending environment it created to curb rising inflation that has prevailed amid the pandemic.

With this cut, the central bank's key interest rate falls to a range of 4.5% to 4.75%.

Ahead of Tuesday's presidential election, the Fed could have rightly celebrated the return of inflation to its 2% target.

At the same time, unemployment remains low at 4.1%.

Essentially, the Fed has fulfilled its dual mandate of keeping inflation and unemployment low.

But reaching that finish line now coincides with Trump's promise to introduce an entirely new tax and economic system. While analysts remain uncertain about how exactly this might come about and how severe it could be, markets have already responded by selling bonds in anticipation of a return of inflation due to a combination of Trump's pro-growth and hawkish trade policies.

This would cause the Federal Reserve to pause its current course of continuous rate cuts.

And that, in turn, would run directly counter to Trump's goal of maintaining lower interest rates as part of a policy to accelerate economic growth.

“Although Trump has shown a consistent preference for accommodative monetary policy, we believe that under a second Trump administration the Fed would engage in a less aggressive rate-cutting cycle due to the inflationary nature of additional tariffs,” analysts at financial group Nomura Holdings wrote in a note for customers this fall.

Trump and Republicans have denied that the tariffs would be inflationary, citing Trump's success in imposing tariffs in his first term without reigniting inflation.

“In his first term, President Trump imposed tariffs against China that created jobs, boosted investment and led to no inflation,” said Anna Kelly, a spokeswoman for the Republican National Committee.

But those $300 billion in tariffs on select Chinese goods were much more targeted than the $3 trillion in blanket tariffs that Trump is now expected to propose. And the inflation environment is now different: During Trump's first term in office, inflation only briefly climbed above 2%.

David Seif, chief developed markets economist at Nomura, said Fed Chairman Jerome Powell will likely decline any direct questions he gets Thursday about how he handles his role and responsibilities, which will change once Trump takes office .

It was Trump who appointed Powell to head the Federal Reserve in his first term. But Trump this year has signaled his willingness to abandon the longstanding principle of maintaining the Fed as an independent body.

“I think I have the right to say, I think you should go up or down a little bit,” Trump said in a Bloomberg News interview at the Chicago Economic Club last month, according to Reuters. “I don’t think I should be allowed to order it, but I think I have the right to comment on whether interest rates should go up or down.”

Seif said that if Trump were to launch the full extent of his proposed tariff plan, it would trigger “an acute inflationary event.” While this isn't necessarily permanent, Seif said, it would require the Fed to pause its monetary easing.

In general, growth is now much more stable. Trump's policies, Seif said, could end up adding fuel to the fire – and forcing the Fed to act in ways that Trump would not look upon favorably.