Weekly Global Economic Update

Week of February 2, 2026

• The Fed leaves rates steady while the president chooses a new Fed chair
• Many countries are attempting to reduce their dependence on the United States
• US trade deals involved commitments to invest in the United States. Will it work?

The Fed leaves rates steady while the president chooses a new Fed chair

• As widely expected, the Federal Reserve’s policy committee left the benchmark interest rate unchanged last week, in the range between 3.5% and 3.75%. The vote was 10 to 2, with two members preferring to cut the benchmark rate by 25 basis points.

Meanwhile, the Fed’s decision came at a time of heightened public attention on the relationship between the Fed and the administration: In this backdrop, Chair Jerome Powell emphasized the importance of policy independence, and said that “it’d be hard to restore the credibility of the institution if people lose their faith that you’re making decisions only on the basis of our assessment of what’s best for everyone.”

Leaving aside the personnel aspects of the Fed, let’s consider the economics: The Fed’s decision was largely based on the view that the economy is stronger than previously expected, which could pose an inflationary risk. Moreover, underlying inflation remains above the Fed’s target. Powell said that “the economy has once again surprised us with its strength—not for the first time.” The committee gave no indication as to when, or even if, it will reduce rates this year.

The Federal Reserve has a mandate to minimize inflation and maximize employment. And although employment growth has been subdued, the Fed has indicated that this is mainly a reflection of immigration policy, which has subdued labor force growth. Meanwhile, productivity is growing rapidly, generating strong economic growth. In this situation, the Fed saw limited need to address slow job growth, especially when the unemployment rate remains low.

Investors were not surprised by the Fed’s decision. Equity prices and bond yields did not move much. However, the dollar rebounded strongly, although that was probably unrelated to the Fed’s decision. Rather, the US dollar had previously fallen sharply when President Trump said he was not concerned with a declining dollar. Later, however, Treasury Secretary Bessent said that “the United States always has a strong dollar policy, but a strong dollar policy means setting the right fundamentals.” This was interpreted to mean that the government is not attempting to reduce the value of the dollar. Hence, the dollar appreciated.

• Two days after the Fed’s decision, President Trump announced that he intends to appoint Kevin Warsh to succeed Jerome Powell as chairman of the Federal Reserve Board. Last year, the administration appointed Stephen Miran to the board for a term that soon expires.

Warsh, like Powell, is an attorney, rather than an economist. His most relevant experience comprised the five years he served on the Federal Reserve Board from 2006 to 2011. At the age of 35, he was appointed by President Bush and served for five years. He was, and remains, the youngest Federal Reserve Board member ever. His tenure coincided with the global financial crisis. The Fed, under Ben Bernanke, cut interest rates dramatically and engaged in quantitative easing (bond purchases) to boost liquidity at a time when banks stopped lending. The policy was a success in that it restored credit market activity, but Warsh was, and remains, a fierce critic of that policy, arguing that it risked significant future inflation.

This suggests that Warsh is an inflation hawk—generally a strong supporter of tight monetary policy even in the face of economic contraction. Yet, today, Warsh has expressed support for a meaningful cut in interest rates, even though inflation remains above the Fed target.

Many countries are attempting to reduce their dependence on the United States

• British Prime Minister Keir Starmer went to China recently. Canadian Prime Minister Mark Carney was there as well. Soon, the leaders of Germany, Finland, and Ireland will also be traveling to Beijing. All of these countries were, until recently, firm allies of the United States, and had often supported US efforts to limit China’s access to advanced technologies and to their own markets. Recently, however, some governments have begun reassessing their economic strategies in light of global trade policy shifts, including new US tariffs and broader uncertainty around long‑standing economic and political alliances.

If the massive US market becomes more constrained or less predictable, then the leaders of these countries would like to find economic access elsewhere. And what better place than China, the world’s second largest economy. Moreover, China has lately eased trade restrictions and encouraged more economic liberalization and integration.

What might this mean for the United States? In a way, the United States could be repeating what China did in the 15th century. At that time, China was the richest nation on earth, having developed the leading technologies of the time and having built an impressive economic infrastructure. Yet, after engaging in pioneering exploration and building trading relations around Asia, the Middle East, and Africa, China turned inward, reducing engagement with the world. In the long run, this led China to fall behind the West and miss the opportunity to benefit from the industrial revolution. Only in the past half century has China reversed its isolation and once again become a global power.

What is the United States doing and how might it affect the long-term role of the country in the global economy? First, it has taken steps to limit certain forms of trade and cross-border economic activity. Plus, the United States has withdrawn from several international organizations and questioned the importance of military alliances. These actions could, over time, reduce the role of the US dollar in the global economy. The dollar has recently declined, hitting a four-year low earlier this week.

Second, the country is cutting back on government funding for some scientific research. Such funding played a major role in fueling innovations that sustained US dominance in multiple industries over the postwar era.

Third, innovation was also fueled by the United States welcoming the world’s best talent. Recent changes in immigration policy may impact its position in science and technology, hence. In recent decades, a large share of innovation and enterprise creation was due to immigrants.

What might a world with lessened US engagement look like? It may take decades before the full implications emerge. And that assumes that the inward turn of the United States is not reversed under a future administration. Often, in US politics, when the pendulum swings too far in one direction, it quickly reverses course. That could happen in the near future regarding trade, migration, and funding for research. In any event, a world in which the United States is less of a dominant political force (even though it will be a major economic force) would be like a return to the 1920s and 1930s, during which, the country was the world’s dominant economy but played only a minor role in geopolitics.

Meanwhile, other countries are not standing still: In Europe, Canada, Singapore, and the United Arab Emirates, among others, there are efforts to attract scientists from the United States. The goal is to boost their ability to develop cutting-edge ideas, industries, products, and companies.

Back to Kier Starmer. As prime minister of the United Kingdom, he leads what was traditionally the closest ally of the United States. There used to be talk of a special relationship. Increasingly, the relationship is viewed as transactional rather than based on emotions or values. Starmer could draw criticism from the United States in going to China, similar to the criticism recently faced by his Canadian counterpart. But Starmer seems to be convinced that the United Kingdom needs a new approach to trade. He took with him several leaders of British companies who are keen to boost their economic relations with China. Plus, if the United Kingdom cannot maintain a special economic relationship with the United States, it will likely seek to restore some of what was lost with the European Union post Brexit. Although it seems unlikely that Britain will rejoin the European Union, a more integrated relationship is a strong possibility.

US trade deals involved commitments to invest in the United States. Will it work?

• In the past year, a pattern appears to have emerged in US trade relations with other countries: First, the administration would impose a steep tariff on imports from a given country. Then negotiations would take place. A deal would be reached in which the US side would typically cut the tariff (although leaving it at a historically high level). In exchange, the other country would agree to boost imports from the United States as well as direct investments in the United States. The latter usually involved a pledge to provide funds that the US government would decide how to invest. Such agreements were reached with the European Union, Japan, South Korea, and Taiwan, among others. 

According to the Peterson Institute, pledges to invest in the United States add up to about US$5 trillion over roughly 10 years—although time frames vary by country. The administration says it is using its leverage to boost investment in the US manufacturing and energy sectors and to end “unbalanced economic relationships.” The question arises as to whether this volume of investment will, in fact, take place; and, if so, what will be its impact.

As to whether it will happen, it is unclear. Many of the announced deals were essentially written lists of terms on which both sides shook hands. There were few formal agreements submitted to legislatures for approval—certainly none to the US Congress. They generally do not include detailed enforcement mechanisms other than the potential to raise tariffs again if the terms are not fulfilled. Also, for market-based economies such as the European Union and Japan, it is not clear how governments can influence private sector actors to boost imports from, and investments in, the United States.

In any event, if there turns out to be a significant increase in inbound direct investment into the United States, there are several potential implications. First, a big increase in investment in the US manufacturing and energy sectors would entail an increase in the demand for labor. Yet, the nation already faces a labor shortage, likely intensified by current immigration policy. Thus, the ability to boost capacity could be hindered or could become expensive.

In addition, due to tariffs, the US manufacturing sector currently faces increased costs that are not shared by foreign competitors. Thus, the ability to compete in global markets could be hampered. As for the energy sector, oil prices are falling, thereby reducing the attractiveness of investing in new capacity. On the other hand, there is a burgeoning shortage of electricity due to massive demand on the part of data centers. Thus, there is a case to be made for more electricity-generating capacity.

Second, a big increase in inbound investment into the United States necessarily implies a big increase in the US trade deficit. Inbound flows of capital increase the demand for dollars, pushing up its value. That, in turn, dampens demand for US exports and increases demand for US imports. The result is a bigger trade deficit. The trade balance and the capital account balance offset one another.

Finally, the terms of several trade deals indicate that the administration will decide how the money is invested. There is a long history of countries in which governments decided on how capital was allocated. At the least, the result was often inefficiency and low returns. Often, capital flowed to players that were less competitive but had political influence. In such cases, investment was largely driven by the need to avert unemployment rather than the need to generate positive returns.