Author: Jin Shi Data
President Trump hopes the Federal Reserve will significantly lower short-term interest rates to 1%. Such a large cut typically only occurs in emergencies, like a sudden recession or financial panic. What is Trump really worried about?
Currently, the short-term policy rate in the U.S. is about 4.25%, while the historical average is 4.6%. The Federal Reserve manages inflation and maintains a healthy economy by adjusting interest rates. If inflation eases, the Federal Reserve may lower rates to around 3.5% in the next year.
However, Trump's own tariff policies have become a stumbling block. By imposing new taxes on imported goods, Trump has increased costs for businesses and consumers. Most economists believe these tariffs will push inflation up by about 1 percentage point, from the current 2.4% to 3.5% or slightly higher.
Trump seems unconcerned about inflation, despite his promise last year to 'significantly lower prices' during his presidential campaign. For months, he has been urging Powell to cut rates, initially asking for a 1% cut, then 2%, and now even over 3%. Jim Bianco of Bianco Research recently joked on social media, 'After July 4th, he might start asking for negative interest rates.'
The Federal Reserve typically cuts rates when it believes inflation is under control and the economy needs stimulation. Lower interest rates make borrowing cheaper, stimulating spending and investment. Under normal circumstances, the Federal Reserve would gradually cut rates, reducing them by 25 basis points every few months. However, when necessary, the Federal Reserve can also cut aggressively. For example, during the Great Recession from 2007 to 2009, the Federal Reserve cut rates by nearly 5 percentage points over 15 months; during the sudden recession caused by the COVID-19 pandemic in 2020, the Federal Reserve cut rates by 1.5 percentage points in two months.
A rate cut of more than 25 basis points usually indicates that something is wrong with the economy. The magnitude of the cut Trump requested is comparable to that during a recession. Rick Newman of Yahoo Finance stated, 'Someone must have told him we are in big trouble.'
Trump's economic advisors, including Treasury Secretary Mnuchin and White House economist Hassett, have publicly been optimistic about the economy — that is their job. But they may share concerns with many economists and investors: the economy seems to be slowing, the job market is weak, national debt is growing to unsustainable levels, and Trump's tariff policies are more harmful than beneficial.
During his two presidential terms, Trump has consistently advocated for lower interest rates to reduce federal borrowing costs. He often talks about 'refinancing' government debt, a tactic he frequently used as a real estate developer.
In recent years, relatively low interest rates have reduced the average interest rate on government debt from 5% in 2007 to 1.6% in 2022. Like other borrowers, the government benefited from the aggressive rate cuts by the Federal Reserve in 2020. However, the government's average borrowing rate has now rebounded to 3.3%, while the federal deficit has ballooned to nearly $2 trillion a year. Annual interest payments on the debt have now exceeded $1 trillion, making it the second-largest federal expenditure item after Social Security.
Trump is not a fiscal hawk. He is pushing for a tax cut bill passed by Congress that will increase national debt by about $4 trillion, and by the end of this decade, total debt will surely exceed $40 trillion. But Trump should understand that soon there will be a president who must deal with the consequences of massive national debt, and that person could be him.
On Tuesday, Trump posted on 'Truth Social': 'Republicans, this 'Beautiful Bill' may be the greatest and most important bill in history, providing the largest tax cuts and border security ever, creating millions of jobs, increasing military spending and veterans' benefits, and more. If this bill fails to pass, it will lead to the largest tax increase in history, 68%!!!'
There are already signs that the surge in federal debt is shaking financial markets. The three major rating agencies have all downgraded the U.S. credit rating. This year's long-term interest rates are higher than they should be, which is a typical manifestation when the market cannot digest excessive debt. This has led to a weakening of the dollar and triggered a trading trend of 'selling U.S. assets', making foreign assets more attractive than U.S. assets.
If Trump gets his way, significant rate cuts will obviously reduce the government's borrowing costs. But this does not help to solve the underlying problem: the debt itself is too high, while the profligate Congress remains indifferent.
Trump may also be concerned about an economic slowdown — GDP showed negative growth in the first quarter. Job vacancies are decreasing, consumer confidence is low (as always), and Americans are increasingly worried about the labor market. If the economy does weaken, the Federal Reserve will undoubtedly cut rates at some point, but it will not be as aggressive as Trump demands.
Banking analyst Chris Whalen believes that the Federal Reserve may eventually lower short-term rates from the current 4.25% to 3%. However, he also believes that due to the additional deficit spending from Trump's tax cuts, long-term interest rates for mortgages and other consumer and business loans are more likely to rise than fall. This could lead to a stagflation scenario: stagnant growth, while inflation and interest rates remain high, leaving voters increasingly dissatisfied.
Another reason for Trump's aggressive rate stance may be that he is looking for a scapegoat for a potential failure. He frequently attacks Powell, calling him 'an idiot,' 'a fool,' and 'a stubborn mule,' clearly preemptively blaming him for possible future economic problems. If inflation surges, unemployment rises, or consumer sentiment remains low, Trump can blame it all on Powell — for not cutting rates in time and not listening to the 'smarter president’s' advice.
Most economists believe that the current short-term interest rate set by the Federal Reserve is at a reasonable level. Very few predict a catastrophic situation requiring an emergency large cut in rates. There is a general belief that if the economy weakens further, the Federal Reserve will take action — but they will certainly not act at the behest of the White House.