August 29, 2025
Trump escalated his attack on the Federal Reserve by firing Fed Governor Lisa Cook. While a Fed governor can be fired “for cause” it is not exactly clear what the term means. The issue will most likely end up at the Supreme Court. Trump seems to want the Federal Reserve to adopt a policy consistent with his Administration’s agenda. The Fed’s long-term battle for its independence is at risk. In our opinion, the economic justification for rate cuts later this year is debatable. GDP growth in the second half of the year should average 2.7% which is much faster than its 2.0% long-term potential growth rate. The core personal consumption expenditures deflator is likely to climb 3.1% in 2025, far higher than the Fed’s targeted 2.0% pace. But despite an economic outlook that is inconsistent with lower rates, we think the Fed will cut rates twice between now and December. Despite Powell’s statements that the Fed’s interest rate decisions will be based exclusively on data and that politics will not enter the equation, it saddens us to suggest that the Fed will bend the rules in an effort to maintain its independence. Unfortunately, modest rate cuts are unlikely to satisfy Trump. Depending upon the outcome of the Lisa Cook court case, the composition of the Fed’s rate setting Federal Open Market Committee could be very different — and much more political — by spring.
To justify a September rate cut Powell needs to come up with a semi-plausible economic case for such action. He has shifted attention to the labor market which he suggests has the potential to deteriorate quickly. In his speech at Jackson Hole last week he said, “Overall, while the labor market appears to be in balance, it is a curious kind of balance that results from a marked slowing in both the supply of and demand for workers. This unusual situation suggests that downside risks to employment are rising. And if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment.” That is about as clear a signal as we can get that rate cuts are on their way. Powell would never have been able to make such a statement without at least tacit support from all FOMC members – not just the two who dissented at the last meeting. Rate cuts are coming, justified or not.
How likely is it that the labor market will deteriorate quickly? In our opinion, extremely unlikely. For what it is worth the Atlanta Fed just raised its estimate of third quarter GDP growth from 2.2% a week ago to 3.5% based on the personal income and consumption spending data for July. We have raised our own estimate from 2.5% to 3.0% for the same reason. It is hard to see the labor market deteriorating if the economy continues to expand at a relatively steamy pace.
In our opinion Powell might have a more plausible case if he talked about the labor market not being at full employment which is another Fed goal. There is currently a strong consensus that full employment is achieved when the unemployment rate is 4.2% which is where it is currently. At that level everybody who wants a job presumably has one. But if that were the case, why aren’t wage pressures intensifying? Nominal wages have been growing at 4.0% for the past several years. In real terms they are growing by 1.1%. Prior to the recession real wages were climbing by about 1.5%. Wage pressures seem to be very much in check. Could it be that the full employment level of the unemployment rate is lower than 4.2%? Could it be 3.8%? Who knows? If it is, lowering the unemployment rate to 3.8% would probably require lower interest rates. We do not buy into that argument, but it seems more plausible than some fear that the labor market is poised to deteriorate.
Once the Fed starts to cut rates, how far might it go? That depends on what the Fed thinks is the equilibrium or “neutral” level of the funds rate. That is the rate level that neither stimulates nor retards the pace of economic activity. The problem is that the “neutral” rate is unobservable. None of us – the Fed, Trump, or private sector economists – know what it is. We are all guessing. Right now the Fed believes that it is 3.0% but it could be higher. At the June FOMC meeting 6 out of 19 Fed officials believe it could between 3.5-4.0%. None of the FOMC members believe that the “neutral” rate is lower than 2.5%. Trump has said that the funds rate is about three percentage points too high. Given that the current funds rate is 4.25% that suggests that he thinks the “neutral” rate is about 1.25%. None of the current FOMC members think that a “neutral” funds rate is anywhere close to 1.25%. But they may not be around for long.
The reality is that the composition of the FOMC could change substantially between now and the spring. Trump’s 1.25% “neutral” funds rate is inconceivable to current FOMC members. But what if by spring the FOMC is made up of a majority of Trump-influenced members? All bets are off. The funds rate could end up anywhere. That is the scary part.
Trump wants to control the Federal Reserve and force them to cut rates to the 1.25% or so that he thinks is appropriate. Thus far he has appointed Stephen Miran, an avid Trump ally, to fill the seat of recently departed Adriana Kugler. He has fired Fed Governor Lisa Cook which could give him another seat to fill. If he wins that fight, he will be able to fire at will any Fed Governor who does not do as he wishes. By March or April of next year he could have effective control of the Fed’s Board of Governors. This is important because the Board appoints the presidents of the 12 Federal Reserve Banks. The term for the current 12 Reserve Bank presidents ends on February 28, 2026. Thus, the seats of all 19 FOMC members are at risk. The makeup of that committee could be every different by the spring and the Federal Reserve will have lost the independence it fought so hard to win from the Treasury in 1951. That is a dangerous idea.
Stephen Slifer
NumberNomics
Charleston, S.C.
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