The More Trump Pressures the Fed, the Fewer Rate Cuts He Gets

The Political Battle Over the Federal Reserve

The Trump administration has intensified its criticism of Federal Reserve Chairman Jerome Powell in recent weeks, as the president continues to push for lower interest rates. However, the more he voices his demands, the less likely it is that he will achieve his real goal: reducing government borrowing costs and making mortgages more affordable.

At the core of this conflict lies a broader ideological struggle between institutional expertise and populist politics. It's a question of whether independent experts, operating at arm's length from elected officials, can manage the economy more effectively than politicians who are subject to the pressures of daily governance.

President Trump’s perspective aligns with the Latin saying "vox populi, vox dei," meaning "the voice of the people is the voice of God." This reflects his belief that public sentiment should guide policy decisions. In contrast, the Federal Reserve was deliberately designed to remain insulated from short-term political pressures, ensuring that monetary policy is based on economic data rather than electoral considerations.

Disagreements on Tariffs and Economic Policy

One of the key points of contention between the White House and the Fed is the impact of tariffs on prices. The administration believes these tariffs have minimal effects on inflation, while the Fed remains cautious. Having previously underestimated the inflationary pressures under the previous administration, the Fed is waiting to see if tariffs lead to higher prices before considering rate cuts.

Republicans have used both Powell’s delayed response to inflation and the Fed’s handling of a major office redevelopment project—visited by Trump last week—as ammunition to pressure the central bank into lowering rates. However, these criticisms are largely symbolic, aimed at influencing the Fed’s decisions rather than addressing substantive issues.

Trump has suggested slashing interest rates by 3 percentage points, a move that would represent a dramatic shift and disrupt traditional economic models. While such a drastic reduction could lead to rapid inflation, it’s possible that this is just political rhetoric. More realistically, Trump may be seeking earlier and larger rate cuts than what the market currently anticipates.

Futures markets currently price in almost no chance of a rate cut in the near term, with a 60% probability of a cut in September and an expected 1 percentage point reduction by mid-2024.

The Importance of Fed Independence

The way rate cuts are implemented matters significantly, as the Fed’s institutional structure plays a critical role. If the Fed were to cut rates due to political pressure from the president, it could erode investor confidence and drive up Treasury yields. Signs of this concern have emerged every time Trump criticizes Powell, including during a recent attack.

After Trump called for a three-point rate cut, the New York Fed’s measure of the 10-year term premium—a gauge of the extra yield investors demand for locking up money for a decade—rose to 0.84 percentage points. This is a significant increase compared to 0.6 points after similar attacks in April and zero a month before the last election.

As political influence grows in monetary policy, inflation volatility is likely to rise, prompting investors to demand higher compensation for long-term investments. This dynamic could lead to higher mortgage rates and increased financing costs for long-dated government debt, which is contrary to Trump’s goals.

The Risks of Politicizing Monetary Policy

If Trump attempts to remove Powell before his term ends next May or if Republicans push for changes to the Fed’s governing laws, the central bank could become more susceptible to political pressure. Investors would expect politicians to prioritize short-term growth over long-term stability, especially around elections. This could result in higher bond yields, leading to higher mortgage rates and increased borrowing costs.

This risk was demonstrated in the U.K. when the Bank of England became independent in 1997. Within days, bond yields adjusted to reflect a third of a percentage point lower inflation expectation over the long run, allowing for permanently lower interest rates.

Mortgage Rates and Fed Policy

Trump’s assumption that Fed rate cuts will automatically lead to cheaper mortgages is flawed. The standard 30-year fixed-rate mortgage depends more on long-dated Treasury yields than on the overnight interest rate set by the Fed. Despite the Fed cutting rates by a full percentage point since September, the 30-year mortgage rate has actually risen from 6.2% to 6.75%.

While I support the Fed’s cautious approach to the potential inflationary effects of tariffs, there is a reasonable argument for beginning rate cuts sooner than the market expects. Factors like low tariff-driven inflation, manageable inflation levels, and high interest rates relative to the strong economy suggest that a case can be made for faster cuts.

However, the decision to cut rates must be based on economic data, not political pressure. Recent trade deals have involved tariffs that, while high, are far below the levels seen earlier this year. Inflation expectations remain stable, private-sector hiring is weak, and wage growth has slowed. Meanwhile, signs of stress from high rates are evident in rising delinquencies for student loans, credit cards, and auto loans.

Conclusion

It’s understandable that Trump finds Powell difficult to work with, but the consequences of undermining the Fed’s independence could be severe. The bond market is already signaling the risks of politicized monetary policy. As Trump continues his campaign against the Fed, he may soon discover that negotiating with the bond market is even more challenging.