With the nomination for the next Federal Reserve Chair approaching to succeed Jerome Powell, whose term ends in May next year, Capital Economics notes that U.S. economic conditions may limit the extent of rate cuts, falling short of President Trump's expectations.
**Core Conflict: The New Chair's Fiery Inauguration** In a report last Thursday (December 18), Capital Economics highlighted that the recent AI-driven investment boom is just the beginning of a multi-year capital expenditure surge. Despite weak labor markets dragging on consumption, GDP growth is projected to remain robust at 2.5% in 2026 and 2027.
The firm predicts: "With core inflation likely to stay above the 2% target for an extended period, we expect only a 25-basis-point Fed rate cut in 2026—setting the stage for immediate tension between the new Chair and President Trump."
Trump is reportedly considering National Economic Council Director Kevin Hassett, Fed Governor Christopher Waller, and former Fed Governor Kevin Warsh. Prediction market Kalshi data shows Hassett leading with 54% odds, followed by Warsh (24%) and Waller (14%).
Trump has vowed to nominate someone who "strongly believes in aggressive rate cuts." After the Fed's recent 25-basis-point cut to 3.5%-3.75%, he complained the reduction "should have been at least doubled." Earlier this year, he even suggested rates should drop to 1%—a level typical during recessions, not healthy growth periods.
**Economic Wildcards: AI Boom vs. Sticky Inflation** Capital Economics emphasizes that while job markets show signs of stagnation, the AI boom will sustain economic vitality, keeping household incomes stable. As AI applications expand from tech to finance, real estate, and healthcare, business investment is forecast to grow 6.5% in 2026, accelerating to 7.4% in 2027.
Economists note AI-driven productivity gains could offset labor market tightness from Trump’s immigration policies, but his tariffs may entrench inflation.
While a Trump-picked Fed Chair might push for deeper cuts, this would require consensus among policymakers. Overly aggressive easing could backfire. The firm warns: "A dovish Chair appointment might trigger looser policy, but only if the Trump administration undermines FOMC independence and inflation credibility—risking higher long-term rates."
Hassett has notably asserted independence, stating Trump’s views carry "no weight" in FOMC rate decisions.
**Hawkish Resistance: Mester’s Rate-Freeze Call** Cleveland Fed President Loretta Mester reportedly said Sunday that after three consecutive cuts, she sees no need for further U.S. rate adjustments in coming months. She expressed greater concern over persistent inflation than labor market fragility, which drove this year’s 75-basis-point cuts.
Mester suggested holding rates at 3.5%-3.75% until at least spring 2026, when the impact of Trump’s tariffs on supply chains becomes clearer. She also cautioned that November’s 2.7% CPI rise may understate 12-month inflation due to data distortions.
"My baseline is we can stay put until clearer evidence shows inflation returning to target or substantial labor market weakening," she said. Earlier this month, Mester emphasized prioritizing inflation control and leaning toward tighter policy.
As a 2026 FOMC voting member, she favors a slightly restrictive stance to pressure inflation downward.
**Dovish Dissent: Citi Foresees Deeper Cuts** Citi Research analysts project 2026 GDP growth near 2%, inflation nearing the Fed’s 2% target, and ongoing labor market softness—paving the way for 75 basis points in cuts (triple Capital Economics’ forecast), lowering rates to 2.75%-3.0%.
"Risks skew toward faster unemployment rises, prompting swifter, larger cuts. We don’t expect 2026 growth or labor demand rebounds. Instead, hiring weakness will persist, slowing income growth and consumer spending," Citi noted.
**Dollar Dilemma: Politics vs. Fundamentals** The 2026 dollar trajectory hinges on the Fed’s policy path relative to other central banks. AI-driven U.S. economic resilience and stickier inflation may allow later, slower easing—supporting the dollar. However, political interference and policy splits pose key threats. On Monday in Asia, the dollar index hovered narrowly near 98.65.
(Chart: Dollar Index Daily, Source: EasyForex) At 09:23 Beijing time, the index stood at 98.63.
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