Trump’s Pro-Growth Policies Are Complicating Powell’s Path Forward
President-elect Donald Trump’s pro-growth agenda is presenting new challenges for Federal Reserve Chair Jerome Powell as he navigates the upcoming year. The Fed’s recent decision to lower interest rates by 25 basis points to 4.5% was expected and free from political influence. However, indications suggest that the December meeting could present more complexities. Over the past year, the Fed has reduced rates by 75 basis points to support ongoing economic growth. While the committee has observed a general easing in labour market conditions, it notably removed previous mentions of slowed job gains. Similarly, the statement expressing confidence in inflation’s movement toward the 2% target was also omitted. These changes have led investors to anticipate a potential rate cut delay, shifting expectations from December to January. Nonetheless, we believe another rate cut at the next meeting remains likely, given the time required for the administration to implement its proposed changes.
Uncertainty around government policy and the strong performance of the U.S. economy have led investors to substantially delay their expectations for rate cuts in 2025. Options markets now anticipate three more rate cuts before the Fed concludes the easing cycle at 3.75%. Trump’s growth-focused agenda, along with investors scaling back on rate cut bets, has driven the U.S. dollar to its highest level since July 2023.
Bank of England’s Rate Cut and Hawkish Outlook Signal Gradual Easing
The Bank of England (BoE) cut its benchmark interest rate by 25 basis points to 4.75%, as anticipated by markets. Eight out of nine policymakers supported the cut, with one dissenting. Following steep losses against the U.S. dollar on Wednesday, the pound recovered, pushing GBP/USD closer to $1.30, and GBP/EUR back to 1.20. However, sterling's drop against other high-beta currencies suggests that broader global sentiment and a cooling of “Trump trades” primarily influenced recent FX movements.
Despite the rate cut, the BoE’s tone was seen as hawkish. Policymakers stressed the need for a restrictive monetary stance, signalling a preference for a gradual easing approach. The central bank now forecasts inflation to rise from 1.7% to around 2.5% by year-end, with an estimated GDP increase of approximately 0.75% at peak impact within a year and a temporary inflation bump of nearly 0.5 percentage points. These revised projections reflect anticipated fiscal tightening following the UK Budget. Consequently, a rate cut in December seems unlikely, and traders foresee only two additional quarter-point reductions from the BoE by the end of next year, with just under a 50% probability for another cut.
Germany's Finance Minister Dismissal Sparks Euro Pressure and Potential Snap Elections
Chancellor Olaf Scholz's dismissal of German Finance Minister Christian Lindner has paved the way for potential snap elections early next year, adding fresh pressure on the euro. With the coalition now fractured, Germany faces increased uncertainty and reduced policy flexibility. Investors initially reacted by selling German government bonds, as Lindner’s replacement could signal greater bond issuance, diverging from his fiscally conservative stance.
The euro remains highly sensitive to global developments, with EUR/USD trading near $1.0770 and showing a growing downside bias as analysts worldwide lower their year-end forecasts for the currency. The European Central Bank is likely to make deeper cuts than the Fed, and German growth is expected to stay sluggish next year. However, a drop below the $1.05 level is unlikely unless Trump enacts a broad 20% tariff on all U.S. imports.
