【MACRO Insight】Trump pressures the Fed to cut interest rates - Differences between US fiscal and mon

It‘s no secret that Trump wants lower interest rates and more of a say in monetary policy, but while he has the power to nominate the Fed chair and two vice chairs, they must be confirmed by the Senate. It would be a mistake for the Fed to cede more independence to this or any future president, so it’s reasonable to doubt it will do so. But Trump may have found a back door to force the Fed to cut rates : fiscal tightening. The Fed‘s monetary policy draws a lot of attention and is often criticized. Less noticed is the impact of fiscal policy, which in recent years has been at least as influential as the Fed’s historic moves.

Since the Federal Reserve began its fight against inflation, there has been a huge divergence between U.S. fiscal and monetary policies. The Fed has tried to slow economic growth by raising short-term interest rates, which it has raised by more than 5 percentage points in just over a year, starting in 2022. This was the largest rate hike in 50 years, and it only retreated slightly last fall. Since the start of the rate hike, the Fed has also reduced its balance sheet by more than $2 trillion, about a quarter of its original size.

Fiscal policy has taken the opposite path. Since the spring of 2022, Congress has injected a large amount of fiscal stimulus into the economy in the form of cumulative deficits of $4.2 trillion, or about 6% of gross domestic product (GDP) over the same period. By comparison, annual deficits have averaged 2.6% of GDP since World War II. This includes the huge deficits that Congress incurred during the 2008 financial crisis and during the pandemic to support the collapsed economy. Of course, these measures are correct, as they have helped the United States successfully avoid a recession in recent years.

It's unclear how far this goal can be achieved, but the mere threat of spending cuts may already be dampening sentiment and holding back the economy. Signs are piling up , with consumer confidence falling for the first time in six months in January. The Bloomberg US Financial Conditions Index has fallen 37% over the past two weeks, suggesting that economic activity is slowing. The 10-year Treasury yield has fallen 50 basis points to 4.3% during that period and is rapidly approaching the two-year Treasury yield, a trend many economic observers see as a harbinger of an impending recession.

However, Trump's tariff threats boosted the dollar again last week, but due to signs that the US economy is cooling and concerns that the trade war will further weaken the dollar, more and more investors are shorting the dollar. Asset management companies and hedge funds have also joined the ranks of bearish dollar. On Wall Street, Morgan Stanley and Societe Generale warned clients that long the dollar is an overcrowded trade that may not hold. In their view, the argument around the dollar will only get darker.

The dollar has long benefited from the prospect of import tariffs that could reignite inflation and keep interest rates higher, but now there are greater concerns that all the uncertainty surrounding tariffs could undermine an economy that has already shown signs of cooling. As a result, expectations for a rate cut by the Federal Reserve have increased, weakening the dollar‘s appeal. The aura of U.S. economic exceptionalism that supported the dollar’s 7.1% surge last quarter is fading as investors continue to assess Trumps domestic and foreign policies, including cutting federal spending and brokering a peace deal between Russia and Ukraine.

The dollar extended gains on Friday as acrimonious exchanges between Trump and Ukrainian President Volodymyr Zelenskiy led to the collapse of a peace deal with Russia and a possible deal on key minerals. U.S. Treasury Secretary Jeff Bessant reiterated in an interview after the Oval Office altercation that tariffs could bring in significant revenue. However, a renewed focus on European defense could ultimately boost the region's currencies against the dollar.

Headlines about tariffs in the U.S. tend to be bullish for the dollar because they raise the cost of imported goods while potentially hurting demand for those goods and reducing the need for currency to buy them. Meanwhile, pending home sales fell to a record low last week and jobless claims rose to their highest level this year, in part because of layoffs announced by federal agencies, reminding investors of the headwinds facing the U.S. economy.

Economists and market analysts are cautious about these changes, believing that the existing economic indicator system needs to be maintained to ensure the stability and comparability of data. At the same time, the US dollar market has also fluctuated, with investors' bearish sentiment on the dollar gradually increasing and market expectations for the Fed's interest rate cuts also heating up.