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While President Trump’s push for lower interest rates in 2025 has dominated headlines, I think there are several reasons to look ahead to next year and consider potentially meaningful shifts in the Federal Reserve’s structure, responsibilities, and process. These changes could affect the central bank’s independence and ability to set effective monetary and regulatory policy, and ultimately, they could impact the value of the US dollar, the term premia embedded in longer-term bond yields, and the multiple at which US stocks trade.
Personnel is policy
A dovish tilt to Fed rate decisions will be viewed positively only if the data supports it —otherwise, the dollar could decline and longer-term yields could rise as the market prices in higher inflation and less certainty about the efficacy of US monetary policy. In other words, the administration’s push for short-term rate cuts may come with a price if the Fed deviates from its established playbook.
Of course, that playbook is only as effective as the people who apply it. We were already facing a change in the Fed chair by May of 2026, but now, with the president attempting to fire Lisa Cook, a member of the Fed Board of Governors, it is possible that a majority of the seven Board members will be Trump appointees — a potential replacement for Cook, plus Michelle Bowman, Christopher Waller, and newly appointed member Stephen Miran. Bear in mind that the Board members are among the 12 members of the rate-setting Federal Open Market Committee (FOMC), with the others including the president of the Federal Reserve Bank of New York and four additional regional Reserve Bank presidents, who serve rotating one-year terms. (There are 12 regional presidents, but only New York’s has a permanent seat on the FOMC.)
In 2026, the makeup of the Board of Governors will matter for three key reasons:
1. The terms of all 12 regional presidents will end on the last day of February 2026 and the Board will ultimately decide who fills these important roles for the next five-year term. It seems plausible that we could see a Trump-stacked Board reject the reappointment of a hawkish regional president or, at a minimum, influence the thinking of regional presidents as they seek reelection.
2. The Board is responsible for bank regulation, not the FOMC (though that responsibility could shift, as I discuss below). That suggests Trump’s views on deregulation could gain more traction in a newly constituted Board.
3. The Board has final approval authority over the discount rate (the interest rate at which eligible financial institutions can borrow directly from a Federal Reserve Bank; it functions as a ceiling for the federal funds rate).
Altering the Fed’s toolkit?
As decisions about the Fed’s personnel unfold in coming months, there are several areas where I think potential changes in the Fed’s powers and tools bear watching:
Interest on excess reserves — If there is bipartisan support for any current policy position of the Trump administration, it is the desire for the Fed to stop paying interest on the excess reserves that banks are required to hold. Could we see tiering of such payments on tap going into next year as scrutiny around Fed policies grows? This would bring the Fed more in line with other central banks and remove a thorn in the Treasury’s side over payments being made to commercial banks, including foreign banks (rather than money being remitted to the Treasury itself).
Quantitative tightening — We may see the end of quantitative tightening (QT) in 2026 as reserve balances reach the level where they start to impact market liquidity. Thus far, the Fed has been reducing its balance sheet via QT through a drawdown of reverse repos, and more recently the Treasury General Account (TGA) has been drawn down without impinging on bank reserves. Recall that the Fed tapered its drawdown of Treasury securities meaningfully earlier this year to allow for a longer period of rundown with a slower impact on market liquidity. An independent Fed would likely consider matching the TGA account in the future by holding Treasury bills and could plausibly be interested in switching to shorter-duration securities over time in its bond portfolio. But this is another area in which changes in personnel could make a difference in the ultimate decisions, with implications for the composition and size of the Fed’s balance sheet moving forward.
Supervisory responsibilities — Treasury Secretary Scott Bessent has written recently about what he sees as the need to pull back on the Fed’s role as “the dominant regulator of US finance” — a role that he argues has yielded disappointing results since it was expanded by the Dodd-Frank Act. In particular, Bessent has made a case for turning over supervisory responsibility for banks to the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency.
Implications for the US dollar and the bond and stock markets
Changes in the Fed’s powers and policies can of course have a wide range of effects, and I would highlight two potential market implications in particular:
US dollar liquidity — Dollar swap lines (agreements in which the Fed exchanges US dollars for foreign currencies with other central banks) are gaining attention in international circles. While the Fed has been a reliable source of dollar liquidity in times of global turbulence, the impending appointment of a new Fed chair has raised concern among other central banks about whether this will change. The Trump administration has argued this liquidity is a favor to allies the US is not obligated to provide. In response, there are proposals circulating that would enable central banks with substantial dollar holdings to lend to each other rather than rely on the Fed. If this were to transpire, it’s possible that in a crisis we could see these central banks liquidate their dollar reserves (which are invested in US Treasuries), driving a significant disruption in the US bond market and requiring the Fed to step in as a purchaser of last resort or to cap market repo rates.
Yield suppression — Treasury Secretary Bessent and others in the administration have repeatedly spoken about the need for the Treasury and the Fed to “row together” in order to reorient the US economy. The unspoken point is that yield suppression could be needed at some unspecified time in the future to support the move toward more domestic manufacturing and less reliance on China — a vision that could require continued fiscal spending and add to the federal debt. The only true sources of fiscal discipline are the bond market and an independent Fed that sets policy based on the economy rather than the needs of the US Treasury. But if the Fed’s independence is curtailed by those driving increased spending, I’d expect to see the bond market reprice term premia higher. And eventually, a compliant Fed would likely be called upon in the event of an economic downturn to step in and control interest rates to keep the Treasury’s interest cost under control.
A move higher in term premia could also negatively impact the earnings multiple at which stocks trade, as it would incorporate greater uncertainty around the institutional structure of US monetary and fiscal policy. The likely net effect: Participants in both stock and bond markets would be wary of any drift in the Fed’s inflation-fighting capabilities. Higher volatility around inflation outcomes tends to be a negative for asset returns in the long run.
Beyond interest rates: A question of organizational control and future effectiveness
If the administration wields more influence over the Fed, we are likely to see greater scrutiny over the central bank’s resource allocation, research agenda, and personnel decisions. More questions about the size of the staff and day-to-day operations could result in more turnover at the Fed. We could also see a new push for auditing the Fed to create greater accountability around the central bank’s actions. All these developments, if they come to pass, could have a significant impact on the Fed’s decision making, including its ability to act independently and swiftly at a moment of crisis.
While markets are understandably focused on near-term interest-rate decisions, there is a longer-term story here that relates to issues of regulation, supervision, and central bank processes (architecture) that have much broader implications and that I will be monitoring in the months ahead.
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