In the coming months, markets will undoubtedly be focused on President Donald Trump’s choice of who will head the Federal Reserve, and whether that choice will give him the control he seeks over interest rates. However, this is not the only challenge the world’s most powerful central bank will face in 2026. I see six key challenges:
Independence
Markets have a right to be concerned. If President Trump succeeds in undermining confidence in the Federal Reserve's commitment to curbing inflation, the consequences could be dire. However, even if the next Fed chair wants to lower interest rates in line with Trump's preferences, that outcome is by no means guaranteed.
The president must also convince the Federal Open Market Committee (FOMC), the body responsible for setting policy, and risks losing credibility if he fails. Maintaining the confidence of the FOMC, Federal Reserve staff, investors, and the president himself will be a difficult task.
The case of Lisa Koch, the Federal Reserve chair whom Trump sought to remove for good reason, remains highly significant. If the Supreme Court were to actually expand the president's power to dismiss Federal Reserve officials, including members of the Federal Open Market Committee, it would greatly enhance his ability to influence monetary policy decisions and potentially even change the composition of the committee.
Interest rates
Political matters aside, the Federal Reserve has good reasons to keep interest rates steady, as its chairman, Jerome Powell, believes that monetary policy is within a reasonable range of neutrality after implementing three 25-basis-point interest rate cuts last year.
The tension between maintaining labor market stability and achieving the 2% inflation target is expected to lessen. It will take time for sufficient evidence to accumulate to justify further interest rate adjustments.
The economy's momentum appears sustainable, supported by AI investments, tax cuts, and favorable financial conditions. The inflationary impact of tariffs is expected to subside by mid-year and be less severe than feared, thanks to exemptions and renegotiations. Housing inflation has also declined, partly because the Trump administration's hardline immigration policies have contributed to a decrease in household formation.
The Federal Reserve's $6.6 trillion balance sheet
The central bank is expected to continue buying treasury bonds, maintaining a portfolio large enough to ensure that banks have adequate cash reserves and that short-term lending markets operate smoothly.
However, some candidates for the Federal Reserve chairmanship have called for a sharp reduction in the balance sheet. Attempting this would complicate monetary policy management, increasing interest rate volatility and the risk of contagion within the banking system.
Banking Supervision
The 2023 regional banking crisis exposed serious shortcomings in the supervisory process and culture. Vice President Michelle Bowman called for a focus on the core issues of bank safety and soundness, and for simplifying complex and redundant regulations.
The goals are logical, but how they will be implemented in practice remains unclear. Simply relaxing restrictions could expose taxpayers and the economy as a whole to serious risks.
stablecoins
Federal Reserve Governor Christopher Waller has proposed that the central bank offer limited accounts to fintech companies with limited banking licenses, allowing, for example, issuers of stablecoins to deposit their reserves with the central bank. However, unlike traditional central bank accounts, these accounts would not pay interest, would not offer daytime overdrafts, and would not allow access to loans from the central bank's discount window, thus limiting their usefulness, particularly during times of crisis. How this issue is resolved will play a significant role in determining the future of the U.S. payments system.
Central Bank Monetary Policy Framework
The central bank's communication system needs reform. For example, its quarterly summary of economic forecasts focuses on prevailing expectations and hides the real reasons for disagreements about the appropriate interest rate path, whether these are differences in economic forecasts or in how monetary policy should respond.
The best approach would be for the task force to publish its projections along with alternative scenarios, similar to what the European Central Bank does. This would help market participants understand how the Federal Reserve might react if the economy deviates from the baseline forecast, thus making monetary policy more effective.
However, despite Federal Reserve Chairman Jerome Powell hinting last May that changes were possible, no action has been taken so far.
The challenges facing the Federal Reserve are profound—in the case of monetary policy—and broad, extending to areas such as supervision and payments. It will be interesting to see what unfinished business the new chair will have to address.
