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It is likely that 2025 will bring tension between the Federal Reserve and the Federal government. After last week’s strong jobs report, the possibility of further interest rate cuts has greatly diminished, and everything is pointing to higher bond yields which are rising to their highest levels since 2023. The futures market is now predicting only one interest cate cut in September. Indeed, some analysts are even beginning to consider the possibility of rate hikes in 2025, after a University of Michigan survey showed consumers’ inflation expectations jumped to 3.3% in January from 2.8% the month prior. Stocks are now back to pre-election levels.

The showdown this year will be between an independent Federal Reserve, whose job is to control inflation through higher interest rates, and the Trump administration, which wants control over the Fed and wants it to cut interest rates to stimulate the economy ((Interest rates are far too high”- Donald Trump, January 7th).

This represents a conundrum for the inbound Republican administration. Tariffs and deportations are inflationary. Inflation brings the need for higher rates. Higher rates are bad for the economy and the stock market, which then drives tax revenues lower, meaning that the federal government will have to borrow more or print more money, which is not just inflationary, but increases the fiscal burden of the interest the government pays on its existing pile of debt, which is already at an all-time high. Trump called Fed Chairman Powell (whom he himself nominated in 2016) an “idiot” for raising interest rates in 2020, despite campaigning on inflation being too high. But without higher interest rates, inflation will run rampant.

Populism prevents austerity, and despite promises to lower the public debt, the bond market is punishing populism with much higher bond yields, now flirting with 5% on the ten-year bond. Higher yields are making the stock market wobble. The bond market thinks that the inbound administration will spend uncontrollably and allow an increase in inflation.

Central banks around the world are declaring victory prematurely over the war on inflation. Many economists are concerned that President-elect Trump’s announced policies will drive inflation higher. Tariffs, should they be implemented universally at 10%, might raise up to $2 trillion for the government, but would shrink the economy as other countries retaliate. No one knows if Trump is serious about tariffs. If he is, they will be inflationary, which may lead to higher interest rates. Another issue is mass deportation, which will cause labor shortages in agriculture, housing construction, and restaurants/hotels, thus driving up wages in an inflationary spiral. Remember, population growth equals GDP growth, and population contraction equals economic contraction.

The 2017 Trump tax cuts were temporary and are set to expire at the end of the year. These tax cuts cost the government approximately $4 trillion. Trump would like to extend them permanently, despite the $36 trillion of Federal debt. He pledges to decrease government spending to afford this.

The much-vaunted, newly created Department of Government Efficiency (DOGE), to be led by Elon Musk, is already balking at that task. Musk admitted on January 8^th that his agency most likely will not make the $2 trillion of budget cuts he has promised since October. Since there is only $1.7 trillion of discretionary spending at the US government, $2 trillion dollars of savings implies cutbacks in Social Security and Medicare. Musk approvingly re-tweeted Utah Senator Mike Lee’s quote to eliminate the Federal Reserve entirely because it is “unconstitutional.” Few think that Wall Street would approve of that.

The stock market has been characterized for the last few years by “liquidity”, as the Fed grew its balance sheet and stimulated the economy despite higher short-term interest rates. The Fed balance sheet is now shrinking through quantitative tightening, taking money from its reverse repo facility, which has been drawn down by $2.1 trillion, and is now minimal. Henceforth, the Fed will run down their balance sheet by taking money out of bank reserves instead, and that will tighten liquidity. Think of that reverse repo facility as a piggy bank which is now almost out of coins. The result will be net tighter financial conditions. Add to this the possibility of higher rates and higher uncertainty, and we have a recipe for volatility in 2025.