President Trump's Inflation Dilemma Complicates Fed Policy Path
January's Consumer Price Index (CPI) report has intensified President Trump's promise to curb inflation. Higher-than-expected inflation sent shockwaves through markets, pressuring stocks and pushing up bond yields. This has led investors to temper expectations for an interest rate cut, with some even speculating about the possibility of a hike.
Economist Nouriel Roubini warns that a delayed rate cut could trigger a "collision course" between President Trump and the Federal Reserve. "Even just keeping them on hold is going to put [Powell] on a collision course with Trump, because Trump wants to cut rates now," Roubini cautions. "We're already seeing those tensions, and they're going to build up."
President Trump has repeatedly urged the Fed to lower rates, citing the compatibility of lower interest rates with his tariff agenda. However, Fed Chair Jerome Powell has signaled reluctance to cut rates prematurely. Powell told Congress, "We want to keep policy restrictive for now."
Roubini and Moody's Analytics chief economist Mark Zandi warn that Trump's proposed policies, including tariffs, could exacerbate inflationary pressures. Roubini asserts, "Tariffs... are inflationary and reduce growth." Zandi echoes concerns, emphasizing that tariffs will contribute to higher inflation, rising interest rates, and curtailed economic growth. This would further complicate the Fed's upcoming policy decisions.
Moody's Analytics projects that fully implemented tariffs on Canada, Mexico, and China could increase consumer price inflation by 0.5% within a year and lower real GDP by 0.6% over the same period. The potential for a trade war also poses a risk to equities, with Goldman Sachs' David Kostin estimating that every 5% increase in US tariff rates could reduce 2025 S&P 500 earnings estimates by 1% to 2%.
Roubini anticipates the S&P 500 to underperform with "single digits" this year even with "moderate" Trump policies. However, he warns that "bad policies" could force the Fed to maintain current interest rates, potentially triggering a market correction.
Despite this, Roubini believes the likelihood of the Trump administration implementing "bad policies" is mitigated by several factors: market discipline, Fed independence, strong economic advisors, and bond vigilantes. Roubini highlights the influence of bond investors, stating, "He cannot control investors... and investors are going to punish [Trump] if his policies are bad for growth and increase inflation."