Trump, Powell, The Budget, Tariffs and...Interest Rates

Wherein I offer Trump a surefire path toward lower interest rates, versus the path he's put us on toward higher rates.

I don’t know where interest rates are going and neither do you. But everything I’m seeing risks pushing them higher, which, as I recently wrote, is increasingly worrisome regarding our public debt, not to mention pressures on mortgage rates, auto loans, bank loans, credit cards, and thereby household affordability. And in every case, it’s an action by the Trump administration that’s implicated in this potential rate assault, meaning, if I’m right, the president will get the opposite of what he wants (i.e., much lower rates). Moreover, in two out of the three cases, he could do himself a big favor and change course today. He won’t. But he could. I even write the speech for him below!

Firing Powell: Firm agreement with this Ben Casselman article from this AM’s NYT:

There are probably three channels through which this works. First, we can have a fun argument about whether Powell and the team should cut the rate they control by a quarter point at the next meeting or two, but there is no case for the multi-percentage-point rate cut Trump is demanding (Mike Konczal goes deep here, as is his wont). We’re already starting to see tariff-induced inflation start to show up in the CPI, and a huge rate cut would not just further juice inflation, it would lead creditors to insist on an “inflation premium,” a higher interest rate to compensate them for higher inflation’s impact on their future earnings.

Second, as I wrote yesterday, the biggest risk to having a Trump lackey lead the Fed is the de-anchoring of inflationary expectations. This is a hard won force that enables the Fed to look through temporary price shocks, not having to tamp out every inflationary bip and bop through rate hikes, because consumers, price/wage setters, and businesses know the Fed is committed to their inflation target.

Third, as the NYT subhead says above, history couldn’t be clearer on this point: central banks in thrall to an authoritarian leader generate excess inflation because their goal is no longer to balance the economic activity/inflation tradeoff. It’s to juice growth on behalf of their master.

Again referencing yesterday’s note on the “you’re fired!” dustup: “there’s no way the rest of the Fed board would vote in support [of a huge rate cut], regardless of what Trump’s appointed chair says, but once he tastes blood, who knows where he’ll stop with the firing.”

The Big, Ugly Budget: It is very likely to push up interest rates. Credible estimates are that the borrowing required to support its highly regressive tax cuts will take the national debt from around 100% of GDP to 130% of GDP over the decade. The rule of thumb is that every percentage point on the debt ratio raises the interest rate on the debt by 2 basis points (hundredths of a percent). That’s six-tenths of a point added to the rate.

Tariffs: The budget creates long-term rate pressures. Tariffs do so in the short term, through the same inflation premium channel noted above. Because tariffs are a tax, their impact on prices and rates should be one-time: they lastingly raise the price level, but not the inflation rate. So, in this case, rate effects should be short-lived.

In our SIEPR issue brief figure A1, we show simulations of this effect run by Mark Zandi. He shows that the most aggressive tariff scenario—#3—which looks uncomfortably close to pronouncements made over the past few weeks, take the 10-year Treasury yield from 4.2% to 4.8% over the next 2-3 years, before turning back down.

If Trump really wanted lower interest rates he could announce that he’d be giving a big, important economic speech later this AM. He could then walk out of the Oval, step up to the podium, and say the following:

“The Trade War is Over! We won, and that’s enough of that.”

Also, Powell’s not so bad. Probably not someone I’d want to party with at Mar-a-Lago, but he’s decent Fed chair. Maybe the guy who appointed him—ME!—didn’t get it so wrong after all.

Thank you and God Bless America (and special thanks to the guy who wrote the Substack post this morning from which I got this speech!)”

We’d then need to unwind the debt implications of the budget bill, but that’s a longer-term, legislative project that we have to do anyway.

If that happens, I swear I’ll hang up my calculator for good and spend a lot more time practicing actual basslines as opposed to budget baselines.