U.S. Federal Reserve policymakers meeting next week are expected to keep interest rates on hold but the larger story unfolding will be how the central bank confronts early moves by President Donald Trump that are likely to shape the economy this year, including demands the Fed continue lowering borrowing costs.

Trump was already complicating the Fed's job with moves to restrict immigration and raise import taxes, and on Thursday told global business leaders he would call on the Fed to cut interest rates.

"I'll demand that interest rates drop immediately, and likewise they should be dropping all over the world," he said at the World Economic Forum in Davos, Switzerland, revisiting a form of pressure he regularly applied to the Fed with little apparent effect in his first term.

In the first days of his new term, Trump tightened immigration rules with an increase in deportations expected, and threatened higher import taxes on Feb. 1, the first of what are anticipated to be a series of steps that could play out in ways that are still unknown.

The challenge for Fed Chair Jerome Powell and his colleagues will be in determining how much to allow uncertainty over what's ahead to influence decisions on monetary policy now, and how much guidance to give about the Fed's outlook.

Go too far and it starts to sound political, said Vincent Reinhart, a former top Fed staff member and now chief economist at BNY Investments, but hold back and it risks misleading the public about what to expect if imported goods become more expensive or the labor force has fewer workers than would otherwise be available.
Guidance from the Fed "is about a forecast, and today any forecast is about political economy. It is hard to do for an independent agency," said Reinhart. "You cannot move monetary policy on the assumption that there will be tariffs or tax legislation by the end of this year. Right now there are a lot of moving parts."

How fast and in what direction Trump's policies spool out in coming months are likely to influence what the Fed hopes will be the last phase of its fight to contain inflation that erupted to a 40-year high in 2022 but is now within about half a percentage point of its 2% target.

After cutting the benchmark interest rate a full percentage point last year, the Fed meets on Tuesday and Wednesday with policymakers likely to keep it in the current 4.25%-to-4.50% range. Data since the Fed's last meeting on Dec. 17-18 has kept intact the core view among Fed officials that inflation will continue to move steadily, if slowly, towards 2%, with a low unemployment rate and continued hiring and economic growth.

'MAXIMAL OPTIONALITY'

The personal consumption expenditures price index the Fed uses for its inflation goal is already nearing 2% on a three- and six-month basis. Policymakers expect solid progress to resume over the next few months but want confirmation in data.

"We view the January Fed meeting as mostly a placeholder," Bank of America analyst Mark Cabana and others wrote. With so much uncertainty "we expect (the Fed) to retain maximal optionality" to resume cuts in March or continue a pause.(Cay) Newsmaker23

Source: Investing.com