Since his first term in office, Donald Trump has been an outspoken critic of Jerome Powell, despite having appointed him as Federal Reserve Chair. Throughout the trade war period and the COVID-19 pandemic, Trump repeatedly criticized Powell’s monetary policy decisions.

With Powell’s term set to end in May 2026, Trump’s recent rhetoric suggests a high likelihood of replacing the Fed Chair now that he holds full control. In addition to the presidency, Trump commands a congressional majority for his first two years, making it politically feasible to also replace members of the Federal Reserve Board.

Such actions could trigger sharp market reactions. The simplest and most immediate response would likely be a sell-off in the U.S. dollar and a surge in demand for gold. Currently, 61% of global fund managers expect the dollar to weaken over the next 10 months. Sentiment among global investors remains broadly pessimistic toward the dollar, U.S. equities, and the overall global economy.

Inflation data, fiscal deficits, political instability, and new tariffs are all contributing to a more defensive, risk-averse market posture. Undermining the Fed’s independence could usher in a period of heightened volatility, as this independence has long been considered a cornerstone of America’s financial stability.

Trump is pushing for rapid interest rate cuts, advocating aggressive monetary easing regardless of the Fed’s technical assessments. Reports indicate he favors a rate reduction of 2.5 percentage points—bringing rates down to around 2%. Unsurprisingly, this aligns with his background in real estate, where lower rates directly boost asset values.

However, such moves risk increasing market instability, particularly if inflation proves persistent or resurges. The Federal Reserve, in contrast, remains more concerned about inflation making a comeback than a sharp slowdown in growth.

In a world without tariff wars, we would likely be witnessing a more favorable economic climate—declining inflation, steady growth, and a Federal Reserve confidently cutting interest rates. However, the Fed’s May statement has taken a noticeably more cautious tone compared to March, signaling rising concerns over both recession risks and stubborn inflation.

Although the median interest rate forecast for this year remains unchanged, more policymakers now project higher rates. Overall, the Fed’s projections have become less optimistic: economic growth forecasts have been revised downward, while unemployment and inflation expectations have shifted higher.

The direction of future policy hinges on two factors: if the labor market stays strong and inflation rises, the Fed will need to maintain or even tighten its stance. Conversely, if economic growth falters and inflation cools, faster rate cuts may become feasible.

Right now, markets are already pricing in risks stemming from escalating tariffs, creating a fog of uncertainty around the future. Tariffs are poised to accelerate inflation while simultaneously slowing growth—both in the U.S. and globally. This dual impact makes it harder to achieve a “soft landing” scenario, where the economy slows gently without crashing.

A lack of policy clarity from the U.S. government has further eroded trust in the dollar, potentially endangering its unique status as the world’s go-to financing currency for twin deficits. Meanwhile, the ongoing U.S.-China decoupling could reignite supply chain disruptions and inflation spikes reminiscent of the COVID-19 era.

While markets currently cling to the soft-landing scenario—perhaps tolerating a 30% market correction—a darker possibility looms: stagflation. This scenario, marked by persistent inflation and slowing growth, threatens deeper structural risks. Should this take hold, markets could experience far sharper corrections, potentially up to 50%.

In essence, these new tariffs may have a two-edged effect—pushing up import prices (inflation) while also dragging down economic growth (recession). If economic data worsens in the coming months or trade negotiations collapse, the consequences could be severe: U.S. equities may slide, safe-haven assets like gold could soar, inflationary pressures on the dollar might intensify, and oil prices—especially for Alaskan crude—could face downward pressure due to weakened demand from key markets like Japan.

The Federal Reserve’s next move on interest rates hinges on how severe the global tariff environment becomes. If the average global tariff rate exceeds 20%, the Fed is likely to overlook short-term inflationary pressures in favor of protecting economic growth—potentially cutting rates sooner. However, if tariffs hover closer to 10%, the Fed appears more inclined to hold rates steady before considering rate cuts in the second half of the year.

Uncertainty around tariffs has already prompted the Fed to maintain its current interest rate stance. Policymakers remain focused on stabilizing inflation expectations and mitigating risks arising from trade conflicts.

The path ahead remains unclear and may not crystallize until late 2025. As trade-related disruptions settle, a window could open for rate cuts within the next 12 to 18 months.

For now, the Fed sees the U.S. economy as resilient enough to withstand elevated rates. Given the high levels of uncertainty, any immediate change in monetary policy would be seen as premature. Unless critical indicators like inflation, wage growth, or consumer spending shift significantly, interest rates are expected to remain unchanged in the near term.

Markets are now caught in a high-stakes “game of chicken,” with three key players—each facing a critical choice. One of them must yield:

1. Trump, by ending the tariff war;

2. China, by making meaningful concessions;

3. The Federal Reserve, by intervening with emergency bond purchases (a new round of quantitative easing).
   
   

Few are betting on China backing down. This leaves a tense showdown between Trump and the Federal Reserve.

If the Fed intervenes—by, for example, buying long-term bonds—it could temporarily stabilize markets and lower yields. However, this would send a dangerous message: enabling Trump’s aggressive policies. On the other hand, if Trump softens his stance—perhaps through direct engagement with Beijing—it would be the most favorable outcome for the markets.

For any data point to significantly move markets, it must shift future expectations—not just reflect absolute figures or month-over-month changes. There are three crucial factors when interpreting market data:

1. The market’s prior expectations;

2. The broader macroeconomic environment;

3. How the data influences forward-looking expectations.
   
   

Markets are particularly sensitive to CPI and PPI readings because these offer early clues about future inflation. Investors are now primarily focused on the outlook 6–12 months ahead—because prices today already reflect the market’s future expectations.

Recent growth, inflation, and especially labor market data have proven resilient. Inflation figures in the first half of 2025 have largely met expectations, giving the Fed justification to stay the course and avoid rash decisions. Inflation appears controlled but remains elevated enough to rule out immediate rate cuts.

For now, the Fed remains in a “wait-and-see” mode, avoiding premature moves until there’s more clarity on the trajectory of inflation, economic growth, and the fallout from trade tensions—especially tariff policy.

The current picture of U.S. consumers remains relatively positive. Consumer spending remains steady, supporting approximately 2% economic growth. However, downside risks persist, particularly if unemployment rises. A further threat lies in the possible spillover of trade tensions into key U.S. service sectors like IT, tourism, and finance, where the U.S. holds a competitive advantage.

Bank deposits have performed better than expected, indicating relative public confidence in the banking system despite current market strains. However, risks are rising on the credit side: banks are becoming more conservative in lending, with falling loan demand across both corporate and household sectors. Regulatory pressures and economic uncertainty are driving this cautious stance, which could weigh on future growth and inflation trends.

Ultimately, the banking sector’s defensive posture signals growing risk aversion and a broader effort to safeguard financial stability amid turbulent economic conditions.

Traders are closely monitoring long-term Treasury yields, particularly the critical 5% level on 30-year bonds. Crossing this threshold could trigger heightened volatility across financial markets.

Why does this matter? The yield on long-term Treasuries, such as the 30-year note, serves as a key gauge of market expectations around future inflation, interest rates, and economic growth. Rising yields signal market concerns about persistent inflation and diminishing prospects for Federal Reserve rate cuts. Alternatively, it may reflect increased selling of bonds—potentially due to fears over rising budget deficits, tariff policies, or forced liquidations from leveraged positions.

If the 30-year yield surpasses 5%, equity and currency markets—especially interest rate-sensitive tech stocks—could face significant turbulence. For now, as long as yields remain under 5%, markets may stay relatively stable. But breaching this threshold could spark a sharp equity correction and ripple effects across the broader economy, particularly if driven by structural deficit concerns.

Long-term Treasuries have become a focal point of both political and economic pressures. A scenario where stocks fall while gold continues to rise, paired with persistently high bond yields, would signal eroding market confidence—suggesting something will eventually have to give.

The weakening dollar may seem manageable in the short term, but when paired with elevated Treasury yields, it points to deeper issues: severe fiscal imbalances that could undermine long-term market stability.

The U.S. budget deficit remains a significant concern. Although Trump has publicly emphasized deficit reduction as a means of lowering long-term risk premiums, the reality is more nuanced. Fiscal adjustments might only lower yields in the long run; in the short term, such policies could actually push long-term rates higher.

How are interest rates determined? Short-term rates are primarily controlled by Federal Reserve monetary policy. Long-term rates, however, are shaped by three key factors:

• Expectations around future central bank policy

• Inflation expectations

• Future supply and demand dynamics for Treasury bonds
  
  

Currently, the U.S. unemployment rate sits at a low 4%, while the budget deficit has swelled to 7% of GDP. A deficit approaching 8–9% of GDP historically aligns with economic recessions. Long-term bond markets appear increasingly worried, reflecting a grim long-term outlook.

With soaring deficits, the bond market faces considerable strain. Treasury yields may experience sharp jumps—so-called "yield gaps"—as investors reassess risks. Despite prevailing market calm, risks seem underappreciated.

If deficits remain elevated, economic growth slows, or interest rates stay high, government debt servicing could become far more expensive, triggering a sudden investor exodus from Treasuries. This would cause yields to spike further and bond prices to decline.

Under these conditions, inflation is unlikely to fall below 2.5%, nor will 10-year yields likely dip below 4%. While AI-driven stock rallies continue to support the equity market, underlying economic growth is still muted, hovering around 1–2%, despite tariffs and global tensions.

For now, the market remains in a delicate balance—expecting a modest stock rally alongside a mild bear market in bonds. No major crashes, but also no euphoric booms.