President-elect Donald Trump campaigned on the promise that his policies will lower borrowing prices and ease the financial burden on American families.
But what if, as many economists predict, interest rates remain high, well beyond their pre-pandemic lows?
Trump may lay the finger at the Federal Reserve, particularly its chairman, Jerome Powell, whom Trump nominated to oversee the institution. During his first term, Trump constantly and publicly chastised the Powell Fed, claiming that it maintained interest rates too high. Trump’s attacks on the Fed have sparked widespread anxiety about political meddling in Fed policymaking.
On Wednesday, Powell underscored the Fed’s independence, saying, “That gives us the ability to make decisions for the benefit of all Americans at all times, not for any particular political party or political outcome.”
Political disputes may be unavoidable in the next four years. Trump’s proposals to slash taxes and impose harsh and sweeping tariffs are a recipe for high inflation in an economy that is nearly at full capacity. If inflation reaccelerated, the Fed would have to keep interest rates high.
Why is there such anxiety that Trump will oppose Powell?
Powell is unlikely to decrease interest rates as much as Trump would like. Even if Powell lowers the Fed’s benchmark rate, Trump’s policies may keep other borrowing costs, such as mortgage rates, elevated.
The significantly higher tariffs that Trump has promised to implement may exacerbate inflation. And if tax cuts on tips and overtime pay — another Trump promise — boosted economic growth, inflationary pressures may rise. The Fed is likely to respond by pausing or stopping its rate decreases, undermining Trump’s pledges of reduced borrowing rates. If inflation deteriorated, the central bank might hike interest rates.
“The risk of conflict between the Trump administration and the Fed is very high,” Olivier Blanchard, former International Monetary Fund chief economist, recently stated. “If the Fed raises rates, it will get in the way of what the Trump administration wants.”
But isn’t the Federal Reserve reducing interest rates?
Yes, but with the economy stronger than expected, the Fed’s policymakers may only cut rates a couple more times, far fewer than had been predicted only a month or two ago.
And these rate reduction may not significantly reduce borrowing rates for households and companies. The Federal Reserve’s benchmark short-term rate can influence credit card, small business, and other lending rates. However, it has no direct power over long-term interest rates. This includes the yield on the 10-year Treasury note, which influences mortgage rates. The 10-year Treasury yield is influenced by investors’ predictions about future inflation, economic development, and interest rates, as well as supply and demand for Treasuries.
An example occurred this year. The 10-year yield decreased in late August as investors braced for a Fed rate cut. However, after the initial rate cut on September 18, longer-term rates did not decline. Instead, they began to climb again, partially due to expectations of better economic development.
Trump has also proposed a number of tax cuts, which might increase the debt. To attract enough investors to acquire the new debt, interest rates on Treasury securities may need to be raised.
“I honestly don’t think the Fed has a lot of control over the 10-year rate, which is probably the most important for mortgages,” said Kent Smetters, an economist and faculty director at Penn Wharton. “Deficits are going to play a much bigger role in that regard.”
Okay, so Trump is fighting with Powell – so what?
Occasional or unusual criticism of the Fed chair does not necessarily harm the economy, as long as the central bank continues to set policy as it sees proper.
However, sustained attacks would likely to erode the Fed’s political independence, which is vital to keeping inflation under control. To combat inflation, a central bank may need to take unpleasant steps, such as hiking interest rates to reduce borrowing and spending.
Political leaders have traditionally urged central banks to do the opposite: keep interest rates low to assist the economy and the labor market, particularly before an election. Research has indicated that countries with independent central banks had lower inflation rates.
Even if Trump does not technically require the Fed to act, his continuous criticism may cause problems. If markets, economists, and business leaders believe the Fed is no longer acting independently and is being pushed around by the president, they will lose faith in the Fed’s capacity to control inflation.
When consumers and businesses anticipate rising inflation, they typically respond in ways that drive higher prices, such as increasing their purchases before prices climb further, or raising their own pricing if they expect their expenses to grow.
“The markets need to feel confident that the Fed is responding to data, not political pressure,” said Scott Alvarez, the Fed’s former chief counsel.
Could Trump simply fire Powell?
He can try, but it will most likely result in a lengthy legal struggle that may even reach the Supreme Court. Powell made it clear during a November news conference that he believes the president lacks the power to do so.
Most experts believe Powell would succeed in court. And, from the Trump administration’s standpoint, such a fight may not be worthwhile. Powell’s term expires in May 2026, when the White House may select a new head.
It is also conceivable that the stock market would tank if Trump made such a bold step. Bond yields are also likely to climb, raising mortgage rates and other borrowing costs.
Financial markets may also react negatively if Trump is regarded as picking a loyalist as Fed chair to succeed Powell in 2026.