Fed may find itself in a bind as it sets stage for Powell's successor

The US Federal Reserve’s meeting this week will begin to set expectations for President Donald Trump’s upcoming nominee to lead the central bank, potentially leaving policymakers in a bind between inflation concerns shared broadly and Trump’s demands for interest rate cuts.

 

A quarter-percentage-point rate cut seems a given at the two-day meeting that ends on Wednesday, but language around that decision and accompanying economic projections will show whether the next chair will take over a body primed against further cuts or more open to argument and with a more dovish near-term outlook.

 

Trump wants lower borrowing costs in particular to boost the housing sector as a way to address broader concerns about affordability that could be central to midterm elections. But delivering on that could pose risks for the next Fed chair, with forecasters expecting resilient growth next year, sustained consumer spending from enhanced tax refunds and, as a result, more persistent inflation.

 

“Regardless of who leads the Fed, in the first order monetary policy is determined by economic conditions,” James Engelhof, chief US economist for BNP Paribas, said during a 2026 outlook call, which anticipates resilient growth and persistent 3 per cent inflation leading to just one rate cut next year following the one anticipated on Wednesday. “The data will suggest little need for aggressive rate cuts.” That could put the next Fed chair into the same box Jerome Powell (pictured) has occupied - pressured by Trump to cut rates in an economy more in need of restraint than stimulus. With midterms potentially hinging on affordability issues and the labor market, pressure on the Fed could mount and tradeoffs intensify.

 

Cutting rates too far may stoke demand, boost hiring, and make mortgages more affordable, while also lifting inflation and, in the extreme, shifting public expectations in a way that makes it harder for the Fed to hit its 2 per cent inflation goal - an outcome current policymakers have sworn to avoid.

 

Deciding on the least risky path has already divided the Fed, leaving the potential for multiple dissents to this week's rate decision. New policymaker projections for rates, inflation and unemployment for the coming year to be released with the statement could show how likely those divisions are to remain through the leadership transition. In September policymakers at the median expected only one quarter-point cut in 2026, with the Fed’s rate ending next year in the 3.25 per cent to 3.50 per cent range, possibly still slightly restraining the economy.

 

Powell’s term as chair ends in May. Trump has said he will nominate a successor early next year, with a Senate confirmation vote to follow.

 

This week’s projections will be hampered by the 43-day government shutdown during October and November. The most recent government reports on the labour market and inflation were for September, leaving policymakers to fill in the gaps with private estimates, their own surveys, and conversations with business and community contacts.

 

Data scheduled after the Fed’s meeting could help clarify whether the economy is tilting towards weaker employment or higher inflation, and thus help ease the policy divide. But it could also extend the current standoff if, as forecasters currently expect, the unemployment rate remains relatively low and inflation holds above target.

 

A recent Reuters poll of economists anticipates economic growth in 2026 of around 2 per cent, slightly above most estimates of the trend rate, with underlying inflation stuck appreciably above the Fed’s target at 2.8 per cent, and the unemployment rate averaging 4.4 per cent, where it was in September.  That would provide little relief for those Fed officials, particularly a group of regional reserve bank presidents, who say they want to be sure inflation - above target for nearly five years - is set to fall before they lower rates much further.