American economists are split pretty evenly about whether the biggest threat facing the economy is inflation or unemployment. On Wednesday, the Federal Reserve issued its own judgment. In cutting interest rates by a quarter-percent and signalling that more cuts would likely follow, the central bank tilted towards the camp which fears the economy may be headed for recession.

Over the next couple hours of trading, markets whipsawed, initially rallying then, when it appeared that the Fed would be easing aggressively in the months ahead, plunging dramatically. Finally, after Chairman Jerome Powell struck a more cautious, hawkish tone at the press conference, the day finished with stocks and bonds marginally lower, the dollar stronger, and crypto assets down for the day but up for the week. It would appear that investors, too, are equally divided. This tug of war could have room to run.

The fact that the Fed is itself deeply divided may explain the skittishness. Nearly half the governors expect there to be two more cuts this year, but a third expect none, and one even voted to raise rates. Meanwhile, way out on a limb is Donald Trump’s newest appointee, Stephen Miran. Just hours into his job, he demanded not only a half-point cut but another five later in the year. Whereas Powell said yesterday that the indicators for the economy are so mixed that “it’s not incredibly obvious what to do,” Miran dissented openly with all his colleagues and said it’s very obvious what needs to happen: cut, baby, cut.

For those who doubted that any Fed governor would come in seeking to bring down interest rates fast and hard just because the President wants him to do it, Miran’s toeing of the party line will be a concern. With inflation still well above the Fed’s target, and signs of growing pressure in the pipeline, that sort of aggressive easing would raise real risks of inflation getting out of control. But in the meantime, it could send asset markets soaring, at least for a while. That may be the administration’s aim.

The next four months will therefore test the nerve of both investors and Fed governors. One analyst summarised the Board’s consensus forecast for the road ahead as “stagflation-lite” — a small uptick in unemployment, a slowdown in growth but not a recession, and inflation edging upwards slightly to about 3%. If that’s what transpires in the months ahead and the Fed keeps cutting interest rates accordingly into a soft but not too inflationary economy, markets will have a favourable tailwind. But if any of those predictions turn out to be off the mark — in particular, if inflation rises above that 3% mark, or alternatively if the economy falls into a recession — investors may get antsy and begin dumping assets.

Markets will probably also pay even closer attention than before to the President’s battle to unseat Lisa Cook, after a federal court ruled this week that he couldn’t remove the Fed governor from her position. So far, investors have remained pretty calm about the risks of Trump seizing control of the Fed and bending it to his will. Miran’s apparent willingness to channel his master’s voice suggests that nonchalance may be misplaced, though. If Trump does find a way to get rid of Cook, then markets could erupt.

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John Rapley is an author and academic who divides his time between London, Johannesburg and Ottawa. His books include Why Empires Fall: Rome, America and the Future of the West (with Peter Heather, Penguin, 2023) and Twilight of the Money Gods: Economics as a Religion (Simon & Schuster, 2017).

jarapley

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