Recent shifts in the U.S. political and financial landscape are significant. President Trump has altered his previous stance of frequently pressuring the Federal Reserve for rate cuts, signaling to new Fed Chair Kevin Warsh that he will "allow the Fed to act independently."
This change not only concerns the direction of U.S. monetary policy but may also overturn the long-standing weak dollar strategy favored by the Trump administration, with profound implications for the global macroeconomic environment.
Last week, Warsh was officially sworn in as Fed Chair. Unlike his previous forceful posture of publicly criticizing former Chair Powell and persistently demanding rate cuts, Trump made clear in a series of interviews and during the swearing-in ceremony that Warsh would have the space to make independent decisions based on economic conditions and combat inflation, provided he does not conflate economic growth with inflation.
Trump even stated directly, "Don't look at me, don't look at anyone, do what you think is right." Although later that day, Trump still expressed a desire for rate cuts following a decline in energy prices, the signal of a policy shift was already clear.
Over the past year, Trump's attitude toward the Fed has remained tough, making last week's remarks a notable turning point. This move at least provides Warsh with operational space to address inflationary pressures and alleviate public livelihood issues affecting Trump's approval ratings. It also indirectly acknowledges that, with inflation nearing 4%, the new Fed Chair has little reason to push for rate cuts.
This change is crucial for investors, as the divergence between market expectations and actual trends continues to widen. Since mid-March, Fed futures markets have completely abandoned the possibility of a rate cut in 2026. The yield on 2-year U.S. Treasury notes has also remained above the policy rate, with futures pricing even indicating a high probability of a rate hike within the next 12 months.
However, a mid-May Bank of America survey showed that half of global fund managers still expect the Fed to cut rates at least once this year, reflecting a widespread market belief that Warsh will ultimately comply with Trump's wishes. If Trump indeed abandons immediate pressure for rate cuts, this market expectation may be completely restructured.
Nevertheless, how long Trump's restraint will last remains uncertain. The direction of the Iran situation is a key influencing factor. However, officials from several central banks, including the European Central Bank, believe that regardless of whether a peace agreement on Iran is reached, there is a current need to tighten monetary policy to demonstrate commitment to inflation targets.
Furthermore, supply bottlenecks in chips and energy driven by the AI boom may cause high inflation to persist for an extended period even after oil price volatility subsides. Productivity gains are unlikely to change this situation in the short term.
Former Fed Governor Roger Ferguson recently pointed out that U.S. inflation has been above the 2% target for five consecutive years, with a cumulative increase of nearly 25%, keeping the pressure on the cost of living for the public persistently high.
Trump's Shift on Monetary Policy May Sideline Weak Dollar Strategy
Trump's softened stance on rate cuts may also overturn another core macroeconomic tenet long held by his administration: promoting industrial reshoring and rebuilding U.S. industrial competitiveness through a weak dollar.
Trump and Treasury Secretary Scott Bessent have previously been cautious in their statements on the dollar. However, the market widely believes a weak dollar is a central measure of their trade and economic reforms and has the support of most White House advisors.
Granting Warsh autonomy over monetary policy has implications far beyond interest rates. Warsh favors reducing the Fed's $6.7 trillion balance sheet, which would tighten dollar liquidity in the long term. He is also skeptical of the Fed's overseas dollar swap lines, which could weaken the dollar's role as the global lender of last resort. Combined, these measures, even considering only exchange rate transmission, are likely to push the dollar higher.
Many economists argue that Trump should abandon the weak dollar orientation, as it not only increases the cost-of-living pressure on the public but also worsens the environment for U.S. overseas debt financing.
Former White House Council of Economic Advisers Chair Glenn Hubbard stated bluntly that using a weak dollar as a tool to revitalize U.S. industry and help disadvantaged groups is a "mistaken choice."
He noted that the U.S. trade deficit persists during periods of dollar weakness, and half of U.S. imports are intermediate goods, meaning tariff policies could actually increase manufacturing costs. He suggested that, with the mid-term elections approaching in November, Trump should abandon the weak dollar proposition and instead achieve policy goals by increasing investment in industrial R&D, simplifying regulations, and conducting vocational training.
Reuters senior columnist Mike Dolan commented that if Trump can provide Warsh with sustained hawkish operational space to curb inflation, it would mean he has simultaneously abandoned the weak dollar policy. This shift will have a profound impact on global financial markets in the coming months and years.
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