Trump’s impossible bet: devaluation or political survival

In the year There is wide divergence between the Federal Reserve and financial markets over the course of US interest rates in 2026. While the Fed is cautious about further cuts, markets are betting on two to three cuts this year.

At the heart of this disconnect is an uncomfortable paradox: President Donald Trump's push for lower prices could be undermined by inflation that threatens his political survival.

Markets will play on the balance reduction in the middle of the year

According to forecasting market platform Polymarket, the probability of a rate cut at the January Federal Open Market Committee (FOMC) meeting stands at just 12%. Most participants expect rates to remain unchanged this month.

But the picture changes dramatically over the long horizon. The probability of a decline rises to 81% in April and reaches 94% in June. For the full year, a two-cut scene commands the highest probability at 24%, followed by three cuts (20%) and four cuts (17%). Combined, the probability of making two or more cuts is over 87%.

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CME's FedWatch tool, which reflects expectations on interest rate futures, paints a similar picture. January's catch rate is 82.8% and is closely related to Polymarket. The probability of at least one cut in June is 82.8%, and the probability of two to three cuts by the end of the year is 94.8%.

The consensus of the market is clear: hold in January, start cutting in the first half and provide two to three cuts in December.

Fed Hawks signal no rush

In the federation, however, a different narrative is emerging. On January 4, Philadelphia Fed President Anna Paulson indicated that further rate cuts may not be appropriate until “the end of the year.”

In the year Paulson, who has a voting seat on the 2026 FOMC, said “some modest further adjustments to the monetary policy may be appropriate later in the year” – but only if inflation stabilizes, the labor market stabilizes and growth stabilizes around 2%. She described the current policy stance as “still a bit restrictive”, suggesting it would continue to work to reduce inflation.

Her opinion is in complete contrast to the expected first half of the market. The message from the federal hawkish camp is clear: don't expect action anytime soon.

December FOMC: Divided Committee

December's FOMC meeting showed just how broke the Fed is.

The committee cut rates by 25 basis points, bringing the target range to 3.5-3.75%. But the vote was split 9-3, a wider margin than the previous 10-2 decision. Two members, Schmidt and Goolsby, opted to hold rates steady. Meanwhile, Miran — widely seen as aligned with the Trump administration — pushed for a 50-basis-point cut.

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The dot plot told a more descriptive story. Although the median forecast indicated only one cut in 2026, the spread was wide. Seven officials forecast no declines, while eight forecast two or more declines. The most aggressive forecast rates could drop as low as 2.125 percent.

The Fed's official guidelines call for one reduction. Markets are divided into two. Why is continuous spacing necessary?

Why Markets Play the Pigeon: The Trump Factor

President Donald Trump is the main reason why markets are reluctant to accept the Fed's hawkish guidance.

Since returning to office, Trump has consistently pushed the Fed for lower rates. December's FOMC vote — in which a Trump-aligned official pushed for stronger easing — exemplifies this dynamic.

More importantly, Fed Chair Jerome Powell's term expires in 2026. The power to appoint a successor rests with the President. Market participants widely expect Trump to nominate someone more sympathetic to his hawkish monetary policy choices.

Structural factors reinforce this view. When the labor market weakens, the Fed has historically cut rates. FOMC meetings are increasing. And tariff policies can slow economic growth, adding pressure to monetary easing.

The market's bet is straightforward: Trump's pressure, coupled with an economic slowdown, will eventually force the Fed's hand.

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The Medieval Paradox: Inflation Is Trump's Achilles' Heel.

Herein lies the central irony. For Trump to effectively pressure the Fed, he needs political capital. But that capital is eroding – because of inflation.

Recent polls show Trump's approval rating on economic policy has dropped to 36 percent. In a PBS/NPR/Marist poll, 57% of respondents disapproved of the economic leadership. A CBS/YouGov survey found that 50% of Americans say their financial situation has worsened because of Trump's policies.

The culprit is the high price. According to data from the Bureau of Labor Statistics, beef prices have risen 48 percent since July 2020, with a McDonald's Big Mac meal rising from $7.29 in 2019 to $9.29 in 2024. Risk. In an NPR/PBS News/Marist poll, 70% of Americans say the cost of living in their area is “unaffordable for the average family,” up from 45% in June.

This complaint is already appearing at the ballot box. Zohran Mamdani, a Democratic state assemblyman, won New York City's mayoral race last November by making the city more affordable. Democratic candidates have captured governorships in Virginia and New Jersey by highlighting the cost of living.

As November's midterm elections approach, more than 30 Republican House members have announced they will not seek re-election. Political analysts predict Republican defeat and Trump's lame-duck status.

Three conditions, no easy way out.

The confluence of monetary policy and electoral politics creates three possible scenarios for 2026 — none of which will give Trump everything he wants.

Scenario 1: Inflation stays high. Trump faces political risks, could lose the midterms and enter lame-duck phase. But high inflation means the Fed has no reason to cut rates. Trump's weakened position further reduces his ability to pressure the central bank.

Scenario 2: The economy freezes sharply. Trump faces even worse political losses as voters chastise the economy. However, the Fed has found a clear rationale for proportionate tapering to support growth.

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Scenario 3: Soft landing with inflation. As economic worries ease, Trump's political standing may recover. But with the economy performing so well, the Fed has little reason to cut rates.

In none of these scenarios did Trump gain both political strength and low interest rates. The two goals are essentially opposites.

Data that determines everything

Upcoming economic releases will serve as critical variables shaping both federal policy and Trump's political fate.

Consumer Price Index (CPI): The decline strengthens the case for moderate cuts and gives Trump political relief. An increase would limit the Fed and strengthen voter response to the administration.

Producer Price Index (PPI): As a leading indicator of consumer prices, a fall in the PPI signals the future CPI measure. A rise in PPI may indicate that tariff-led inflationary pressures are emerging.

Employment data (NFP, unemployment rate): Weakening labor markets will increase pressure for the Fed to cut — but hurt Trump's economic record. Stable employment gives the Fed cover to maintain its prudent stance.

Summary

The Fed is targeting a rate cut in 2026. Hawks like Paulson may not come until the second half. But markets continue to price in two to three, betting that Trump's pressure and Powell's succession will eventually push the Fed into easing.

But here's the paradox: Persistent inflation undermines Trump's political standing, which in turn weakens his leverage over the Fed. The conditions that make Trump less politically attractive make them economically irrational — or take away his power to question them.

“The prices, stupid” applies to Trump, the Fed and market participants as well. Ultimately, inflation and employment data will simultaneously determine the path of US interest rates and the outcome of November's midterm elections. Trump may want both political survival and low rates, but the economy may not afford him that luxury.