Interest Rates: A Thorn in Trump's Second Term

During his second presidential term, Donald Trump has generally achieved his objectives in various areas, including Cabinet selections, deregulation, and immigration enforcement. However, his paramount goal of significant congressional tax cuts remains in the pipeline. Yet, one crucial element is not aligning with his plans: interest rates.

Trump's Discontent with Interest Rates

Trump has expressed dissatisfaction with elevated interest rates on social media, advocating for their reduction as a complement to his tariff policies. However, markets do not share this view, and unlike the politicians Trump confronts in Washington, markets are impervious to intimidation. Stubbornly high rates could potentially mar his second term.

The Federal Reserve's Role

The Federal Reserve sets short-term interest rates that primarily impact banks. Trump has criticized Fed Chair Jay Powell for failing to contain the high inflation of 2022 and beyond. He further denounced the Fed's decision to refrain from lowering rates in January.

Longer-term rates, such as those on mortgages and business loans, are more pertinent to consumers and businesses. While the Fed can influence these rates indirectly, markets also play a significant role. Since September 2024, long-term rates, represented by the 10-year Treasury bond yield, have increased by approximately a percentage point despite the Fed's reduction of short-term rates by a similar amount.

Bond Market Inflation Concerns

The bond market's rise in long-term rates reflects concerns about future inflation. This is supported by other data, such as surveys indicating that consumers anticipate elevated inflation in the coming years.

Two primary factors could contribute to inflation: persistent price increases in specific categories and the impact of Trump's tariffs. While the former is largely outside Trump's control, he can address the latter.

Tariffs and Inflation

Trump is an ardent advocate of tariffs. He has imposed tariffs of 10% on most Chinese imports and 25% on steel and aluminum imports. He has additionally threatened tariffs on Mexican and Canadian imports. Economists predict that these tariffs could further increase prices.

Trump's Options

Trump's control over monetary policy is limited. He cannot directly influence long-term interest rates. If inflation intensifies, rates are likely to rise as investors seek higher returns to mitigate the eroding value of their assets.

Despite their influence on affordability and economic growth, Trump has repeatedly criticized interest rates. As he becomes accustomed to getting his way, political analysts speculate on his potential reactions to market resistance. One possibility is that he may advocate for increased government control over interest rates, including credit card rates.

Potential Risks

Excessive government influence over interest rates could diminish bank profitability and restrict lending, particularly to higher-risk borrowers. This could harm consumers and hinder economic growth.

Additionally, foreign holders of US debt could potentially use higher rates as an economic weapon against Trump's tariff policies. By selling Treasury holdings, they could drive up interest rates and increase borrowing costs for the entire US economy.

While these scenarios may seem improbable, it remains uncertain how Trump will respond to the resistance of a fixed market. Investors and economists will be closely monitoring the situation to assess the potential impact on the economy and financial markets.