President Trump’s D.O.G.E will force the Fed to cut interest rates

Mr. Donald Trump has officially found a way to strong-arm the Federal Reserve into cutting interest rates. Not through direct intervention, but through fiscal policy.

The US president’s Department of Government Efficiency (D.O.G.E) is on a mission for massive spending cuts and federal layoffs, and economists generally agree it will slow down the economy, giving the Fed no choice but to lower rates. It’s actually the perfect setup if you think about it whether Fed Chair Jerome Powell likes it or not.

Moving on, monetary policy and fiscal policy are moving in opposite directions right now. The Fed hiked rates aggressively from March 2022 until November 2024 in efforts to fight inflation, which took the rates up over 5 percentage points in just a year, the largest in 50 years.

Meanwhile, the federal government (under former president Joe Biden) racked up a $4.2 trillion deficit from 2022-2024. Now with Trump back in office trying to cut $2 trillion in govt spending, the entire game is likely gonna flip.

Trump could easily force the Fed’s hand

Now, the US Treasury Secretary, Scott Bessent, says Trump wants to bring the deficit down to 3% of GDP. That would require massive cuts from labor, whether the economy is ready for it or not.

Consumer sentiment dropped for the first time in six months in January. The Bloomberg US Financial Conditions Index fell 37% in just two weeks, and the Atlanta Fed cut its GDP growth estimate in half, from 4% to 2.3% in just a month. The 10-year Treasury yield fell 50 basis points, heading toward a very dangerous recession signal.

If the US economy slows down too much, the Fed will have to cut rates. There’s no getting around it. The latest core personal consumption expenditures (PCE) report, the Fed’s preferred inflation gauge, still sits at 2.8%, above its 2% target.

But if growth tanks and unemployment rises, Powell’s team won’t have much of a choice. The Fed can’t hold off forever if the labor market weakens and spending dries up. The mere threat of these D.O.G.E cuts is already messing with economic sentiment. If businesses and investors expect less government spending, they’ll hold back on hiring and investing, squeezing growth some more.

Financial markets are already reacting, and investors are scared

Trump’s fiscal policy change is a big deal for investors, and so the bond market is already pricing in rate cuts, and that’s a warning sign. It tells us investors expect the Fed to cut rates sooner rather than later, and they’re pretty desperate about it too.

Powell can keep saying inflation is the priority, but if GDP growth slumps and unemployment rises, the Fed will act as the central bank and won’t want to risk a recession just to keep inflation in check.

There’s one problem, though. With Trump’s new tariffs on Mexico, Canada, China, and potentially the European Union, inflation could spike again even as growth slows. That’s the worst-case scenario—stagflation.

If that happens, the Fed might have to hike rates instead of cutting them, and stocks and cryptos will react pretty strongly to that, as they always have.

Meanwhile, the Federal Open Market Committee (FOMC) is reviewing its interest rate framework from the current one that was introduced in 2020 and built for a low-inflation world. It failed spectacularly when inflation surged in 2021, thanks to the COVID-19 pandemic.

Under the 2020 policy, the Fed promised to keep rates near zero until unemployment was low and inflation stayed above 2% for a while. That backfired because by the time the Fed hiked rates in 2022, inflation had already hit 5%, and the US economy was overheating.

Per the FOMC’s January minutes, the Fed is now reviewing quantitative easing (QE), the controversial money-printing strategy that cost the US Treasury between $500 billion and $1 trillion.