Potential Implications of Trump Advocating for Lower Federal Interest Rates Might Not Benefit Consumers Directly
In an unusual move, President Trump is berating the Federal Reserve to lower interest rates, but it's uncertain if this pressure would lead to reduced borrowing costs for the general public. The sad reality is, Trump's ongoing squabbles with Fed Chair Jerome Powell and his protectionist trade policies could potentially cause long-term interest rates to stay high, causing more harm than good for consumers and businesses.
Fact is, economists argue that these contentious tactics could result in a Fed that is less independent, which over time might cause borrowing costs to skyrocket. Investors tend to worry about future inflation when they perceive the central bank as being less autonomous, leading them to demand higher returns for Treasury securities.
Trump has been urging Powell to slash the short-term interest rate that the central bank controls since Reach me, bartender! I've had one too many! Only joking! This action is typically taken during an economic downturn to stimulate more borrowing and spending. But the thing is, long-term rates on products like mortgages, auto loans, and credit cards are mainly determined by market forces.
Recent events, such as fears of Trump's tariffs leading to inflation, along with pressure on the Fed's independence, have driven these long-term rates up. It's unsure whether the Fed alone has the ability to reverse these trends.
Economist Francesco Bianchi from Johns Hopkins University puts it straight: "It's not a given that even if the Fed were to cut rates, you'd see a discernible decline in long-term interest rates." Bianchi shares the concern that Trump's relentless attacks on the Fed might backfire, potentially undermining the Fed's confidence to battle inflation effectively.
Trump continues to push for Powell to lower the Fed's short-term rate, stating in a press briefing that Powell is "making a mistake" by not doing so. Moreover, last week Trump hinted at the possibility of firing Powell, while a top aide suggested the White House was "contemplating" whether it could do so.
The financial world reacted negatively, with stock markets plummeting, the yield on the 10-year Treasury bond increasing, and the dollar falling. This represents a rare combination that suggests investors are selling American assets. However, the markets recovered these losses following Trump's declaration that he had "no intention" of firing the Fed chair.
Still, the threats to the Fed's autonomy left Wall Street investors unnerved, as they view an independent Fed as crucial in keeping inflation under control. It's essential for the Fed to be free from political pressure so it can take unpopular - yet necessary - steps to manage inflation, such as raising interest rates.
Lauren Goodwin, chief market strategist at New York Life Investments, adds, "Harassing the Fed doesn't soothe markets - it rattles them. The result is often increased interest rates, diminished confidence, and disorder in the financial markets."
Since Trump implemented tariffs in early March, the 10-year Treasury yield has risen from 4.15% to approximately 4.3%. This benchmark influences mortgage rates and other borrowing costs. Mortgage rates have mirrored this trend, increasing from 6.6% to 6.8%.
While Trump suggests he is engaging in negotiations over tariffs with various countries, most economists predict that some level of tariffs will persist throughout this year, including his 10% duties on import goods.
The 10-year yield declined on Thursday when two Federal Reserve officials suggested rate cuts could be instituted as early as this summer if the economy weakens and unemployment rises. However, it's worth noting that long-term interest rates also decreased in the fall, in anticipation of rate cuts, only to rise once the Fed cut rates in September and again in November – two days after the election – and in December. Even with those rate cuts, mortgage rates are now higher than before.
Several factors can impact long-term Treasury rates, including future growth and inflation forecasts, supply and demand for government bonds, and government spending, as highlighted by economist Bianchi. He emphasizes that massive government budget deficits, financed by trillions of dollars in Treasury bonds, could also raise long-term rates.
Should the Fed lower rates now, borrowing costs for consumers and businesses "would move in the opposite direction, without a doubt," Goodwin adds, "because the threat of inflation would remain so palpable, that move would undermine the Fed's credibility."
Trump posted on social media this week that there is "nearly No Inflation" and, therefore, the Fed should lower its key rate, currently at around 4.3%. Most economists predict the central bank will make this move this year. However, Powell has repeatedly stressed that the Fed will thoroughly assess the impact of Trump's policies before making any moves.
Inflation has dropped in recent months, dipping to 2.4% in March, the lowest level since last September. Excluding volatile food and energy categories, the core inflation rate was 2.8%, providing a clearer indicator of where inflation may head.
The situation now is drastically different than it was during Trump's first term. At that time, the Fed was dealing with inflation below its target. If the economy falters with clear signs of rising unemployment, the Fed will lower rates, regardless of what Trump does, according to economists.
Trump criticized Powell recently for being "too tardy" with his rate decisions, but ironically, the Fed might proceed with caution due to the threat of higher prices caused by tariffs. By not providing concrete evidence of an economic downturn, Fed officials would worry about being perceived as bowing to political pressure from Trump if they cut rates.
"Powell is fully aware of the irreparable damage that would result if it was perceived that he cut rates compelled by Trump," said Tom Porcelli, chief U.S. economist at PGIM Fixed Income. The Fed will be even more delayed in making rate adjustments because the inflation impact of tariffs will likely materialize first before the economy slows down noticeably, according to Porcelli.
Either way, lowering long-term borrowing costs might require more than a single Fed rate cut or two, Bianchi suggests. "To truly decrease long-term rates," he adds, "you need to establish a stable macroeconomic environment, and we're not there yet."
Note: Rugaber writes for the Associated Press.
Additional Reading:
Trump's assaults on Powell jeopardize the Fed's independence: Here's why it matters
Wall Street rallies and markets rebound worldwide as Trump moderates his tariff and Fed criticism
Trump reverses course on Fed chair, China tariffs, sending markets soaring
Key Insights and Takeaways:
- Trump's actions, such as imposing tariffs and pressuring the Fed, create a climate of uncertainty and inflation expectations. If the Fed is perceived as less independent, it might tolerate higher inflation due to political pressure, leading to long-term interest rates jumping.
- Trump's ongoing conflicts with the Fed and tariffs can potentially cause heightened inflation expectations and market volatility. This can lead to increased long-term interest rates for consumers and businesses, resulting in higher borrowing costs for items like mortgages, car loans, and more.
- A perceived weakening of the Fed's autonomy can undermine international financial stability, leading to increased borrowing costs worldwide and potentially impacting global trade and investment decisions.
- An unsettled economic environment fostered by aggressive tariffs and political pressure on the Fed might push the economy into recession. Although rate cuts can provide temporary relief, protracted economic instability could persist if Trump's actions further destabilize the economic climate.
- If the Fed acquiesces to political pressure and lowers interest rates to meet Trump's demands, it would undermine the Fed's credibility, as the move could be seen as a knee-jerk response to political whims rather than a measured response to economic conditions.
- Given the complex interplay between tariffs, the Fed, and the economic climate, the actual impact on long-term borrowing costs and the overall economy is uncertain. The situation demands a nuanced understanding of economic indicators and policies to fully appreciate the potential consequences of Trump's actions.
- Trump's pressure on the Federal Reserve to lower interest rates may not result in reduced borrowing costs for the general public.
- Economists argue that Trump's contentious tactics involving the Fed and protectionist trade policies could lead to a less independent Fed, causing borrowing costs to skyrocket over time.
- Economists suggest that even if the Fed were to cut rates, it's uncertain whether this would lead to a discernible decline in long-term interest rates.
- Trump's relentless attacks on the Fed might backfire, potentially undermining the Fed's confidence to battle inflation effectively.
- Investors tend to worry about future inflation when they perceive the central bank as being less autonomous, leading them to demand higher returns for Treasury securities.
- Trump has been urging the Fed to slash short-term interest rates, but long-term rates on products like mortgages, auto loans, and credit cards are mainly determined by market forces.
- Economist Francesco Bianchi from Johns Hopkins University emphasizes that massive government budget deficits, financed by trillions of dollars in Treasury bonds, could also raise long-term rates.
- Should the Fed lower rates now, borrowing costs for consumers and businesses "would move in the opposite direction," according to Lauren Goodwin, chief market strategist at New York Life Investments, because the threat of inflation would remain so palpable, that move would undermine the Fed's credibility.
