President Donald Trump has been persistently pushing the Federal Reserve to reduce interest rates. However, even if the Fed complies with this demand, it may not result in decreased borrowing costs for consumers. According to economists, Trump’s continuous criticism of Fed Chairman Jerome Powell, paired with his tariff strategies, may actually lead to higher long-term interest rates crucial for consumers and businesses. Concerns about a less independent Fed could make investors unsettled, fearing future inflation and therefore demanding higher returns on Treasury securities.
Trump has been persistently vocal about his wish for Powell to lower the Fed-controlled short-term interest rate. Traditionally, during economic hardships, the Fed cuts rates to stimulate borrowing and spending. Conversely, it hikes rates in times of economic growth to curb inflation. However, market forces mainly determine long-term rates on mortgages, car loans, and credit cards. Lately, the combination of Trump’s extensive tariffs and his challenges to the Fed’s autonomy is seemingly pushing these long-term rates higher. It’s uncertain if the Fed can fully counteract these developments.
Francesco Bianchi, an economist at Johns Hopkins University, notes that a rate reduction by the Fed doesn’t necessarily lead to a significant decline in long-term interest rates. He suggests that pressuring the Fed might backfire if markets doubt the Fed’s ability to control inflation. Recently, Trump reiterated his call for Powell to lower the short-term rate, expressing his dissatisfaction with Powell’s approach. He even hinted at considering Powell’s dismissal, sparking market turbulence where stock values sank, the 10-year Treasury bond yield increased, and the dollar weakened. The markets eventually stabilized after Trump assured he did not intend to dismiss Powell. Nevertheless, the threats towards the Fed’s independence create unease among Wall Street investors who believe a politically neutral Fed is essential to manage inflation effectively.
Lauren Goodwin, the chief market strategist at New York Life Investments, emphasized that intimidating the Fed does not calm the markets but rather disturbs them. Consequently, the outcome can be precisely the opposite of what the administration desires, resulting in higher interest rates, diminished confidence, and increased market unrest. Since the early imposition of tariffs by Trump in March, interest rates have gradually climbed. For instance, the yield on the 10-year Treasury has risen, influencing mortgage rates which have also increased.
Despite Trump’s ongoing negotiations over tariff policies, economists generally foresee some tariffs remaining throughout the year. Although there have been hints from Fed officials about the possibility of rate cuts if the economy falters, past experiences show that anticipated rate reductions haven’t consistently led to falling longer-term rates. A variety of factors, such as future growth and inflation expectations alongside the availability and demand for government bonds, can influence longer-term Treasury rates. Accumulating government deficits, funded by vast amounts of Treasuries, might also elevate these rates.
Goodwin noted that if the Fed were to cut rates now, long-term borrowing costs might paradoxically rise due to persistent inflation risks that might undermine the Fed’s credibility. Recently, Trump claimed on social media that inflation is virtually nonexistent, thus justifying a rate cut. While many economists predict the Fed will eventually lower rates, Chairman Powell insists on assessing the effects of Trump’s policies beforehand. Inflation figures have recently dipped but excluding volatile sectors like food and energy, core inflation remains a significant concern.
Currently, the economic landscape is significantly different compared to Trump’s initial term, a period when inflation was below target, making rates cuts straightforward if a recession loomed. Now, tariffs are predicted to increase prices temporarily, elevating the threshold for any rate reduction. Economists suggest that undeniable signs of economic decline, such as rising unemployment, would prompt the Fed to slash rates irrespective of Trump’s stance.
Trump has criticized Powell for being perpetually delayed with rate decisions. Ironically, the threat of heightened prices due to tariffs may indeed delay Fed actions. Without concrete evidence of an economic downturn, the Fed might be reluctant to cut rates, fearing it could be perceived as succumbing to political pressure. Tom Porcelli, chief U.S. economist at PGIM Fixed Income, warned of the severe consequences if the Fed appears to act under Trump’s pressure. Porcelli expects a delay in Fed action because of initial inflation pressures before any substantial growth slowdown is observed. Ultimately, Bianchi suggests multiple rate cuts might be necessary to significantly lower long-term borrowing costs, emphasizing the need for a stable macroeconomic environment which is currently lacking.