The midterms give Fed more room to raise rates, mut maybe less reason to do so
The Federal Reserve is supposed to operate independently of politics, but that doesn’t mean it’s immune to election results.
Democrats’ sweeping victories in this past Tuesday’s midterm elections have changed the landscape for the central bank, limiting President Donald Trump’s ability to influence its leadership—and potentially giving Federal Reserve Chairman Kevin Warsh more freedom to pursue his own monetary-policy agenda.
The election results could also reshape that agenda in time, by leading to changes in government spending, the buildout of artificial-intelligence data centers, and other factors that determine the economic outlook. The early read is that the “blue wave” may prove modestly disinflationary in the short term, and perhaps for longer, especially if energy prices remain stable or decline.
The Fed’s independence has faced a series of challenges during Trump’s second term. The president has repeatedly pushed for lower interest rates and sought to remove Fed officials whose policy views or actions he opposed.
Democratic control of the Senate will make it harder in several ways for Trump to reshape the central bank during his remaining years in office.
The Senate confirms presidential nominees to the Fed’s Board of Governors. There is one scheduled vacancy before Trump leaves office: Former Fed Chair Jerome Powell’s term as a governor expires in January 2028, although other governors could step down before then. That means Trump will have to nominate a Powell replacement acceptable to Senate Democrats, or leave the position unfilled.
The election also changes the stakes of the administration’s effort to remove Fed governor Lisa Cook. Even if Trump succeeds in ousting Cook, whom he has accused of mortgage fraud, he can no longer count on replacing her with someone sympathetic to his monetary-policy preferences.
A president who can’t rely on a Republican Senate to approve his nominees may have less incentive to continue pursuing officials he views as obstacles, economists at TD Securities wrote. Political pressure on Powell, Cook, and other Fed officials may ebb.
If Fed governors choose to retire in the next two years, Trump isn’t obligated to replace them. Leaving seats vacant could shift more influence toward Warsh.
The Warsh Fed has already affirmed its political independence by raising the federal-funds-rate target range by a quarter of a percentage point in September, to 3.75%-4.00%, to combat elevated inflation. Trump blamed the “very tough board,” but not Warsh, for the decision.
For Warsh, the postelection environment could offer greater freedom to promote the hawkish monetary policy he historically favored. Still, the political incentives surrounding his leadership are changing.
Warsh’s term as Fed chairman expires in May 2030, well after Trump leaves office. If Warsh hopes to serve another term, he may need the support of a future Democratic administration and Senate.
Warsh’s predecessor, Powell, offered his successor advice about the importance of maintaining relationships with lawmakers. “Our window into democratic accountability is Congress,” Powell said at a press conference in January. “And it isn’t a passive burden for us to go to Congress and talk to people. It’s an affirmative, regular obligation.”
A Democratic Congress could subject Warsh to greater scrutiny, particularly as he seeks to change how the central bank communicates its policy decisions.
As for changes in the economic backdrop, Democratic victories in states such as Texas, Georgia, and Ohio are expected to bring more oversight to the AI industry and the rapid expansion of energy-intensive data centers. The buildout of AI infrastructure has become an essential source of business investment and economic activity.
That could have implications for inflation.
Data centers require enormous amounts of electricity, construction materials, and infrastructure. Slower development could ease some of the demand contributing to higher energy and construction costs. It could also reduce business investment, weakening economic growth. Collectively, these trends could diminish the need for much higher interest rates.
For now, though, futures traders put 79% odds on a quarter-point rate increase at the Fed’s Dec. 8-9 meeting, according to the CME FedWatch tool. The odds that rates will rise at least to 4.25%-4.50% at the Fed’s March 2027 meeting stood at around 45% on Friday.
A robust employment report on Friday morning argued for a heightened inflation watch, as it indicated the economy remains hot despite the Fed’s recent efforts to slow thing down. U.S. employers added 165,000 jobs to payrolls in October, well ahead of expectations, the Bureau of Labor Statistics reported.
A more dovish group of regional Fed presidents will rotate onto the Fed’s rate-setting committee in January, which may change the calculus further, although Warsh has been firm in his stated resolve to return inflation to 2% a year from the current level closer to 4%.
The midterm election has given Warsh more freedom to push for raising rates, if necessary. But whether the economy will need higher rates to cool inflation is now a question.
Write to Nicole Goodkind at nicole.goodkind@barrons.com