Lower rates: Donald Trump's counterproductive strategy

Summary:

Donald Trump's push for lower interest rates, including threats to replace Fed Chair Jerome Powell, risks undermining central bank independence—potentially triggering higher rates amid inflation and deficit concerns.

This is one of Donald Trump's many obsessions: low interest rates. He talks about it all day long. And the more time passes, the more he demands. A few weeks ago, he called for an immediate 100-basis-point cut. On the day of the Fed's last meeting on June 18 he suggested that he should perhaps appoint himself as head of the Fed and that rates should be "two points lower."

On Friday, he even called for rates to be cut to 1% (bearing in mind that key rates are currently in the 4.25-4.5% range). This is a call that Jerome Powell is not prepared to answer at this stage. "I would love for him to resign, he's done a terrible job," the US president said.

Phantom president

Why this obsession? First, because lower rates are more conducive to growth. And above all because the debt burden is very high. According to estimates by Torsten Slok, chief economist at Apollo Global Management, debt interest payments cost the US $3.3bn every day. And 18% of federal government revenue is spent on this item.

By Jerome Powell's own admission, interest rates are currently in restrictive territory (they are slowing down the economy). But with growth remaining solid and the risk of a return to inflation caused by tariffs, the Fed has every reason to remain on hold for the time being.

Hence Donald Trump's desire to appoint someone more favorable to rate cuts to head the Fed. Although he has repeatedly threatened to fire Jerome Powell, this idea now seems to have been ruled out, and the debate is focused on finding his successor. Jerome Powell's term expires in less than a year (May 2026), although he will remain on the Fed's board until January 2028.

However, the appointment of the next Fed chair could come quickly. Last week, the Wall Street Journal reported that the announcement could be made as early as September. This would create a "shadow Fed chair," who could begin guiding market expectations before taking office.

Don't play with independence

Donald Trump seems willing to do anything to get interest rates down. But does the US president's aggressive strategy really serve his cause?

The threats against Jerome Powell and the desire to appoint someone who will be loyal to him weaken both the credibility of the institution and the person he chooses.

Each attack by Donald Trump fuels doubts about the sacrosanct independence of the central bank. This independence is itself key to the effectiveness of monetary policy in the long term, and therefore to the fulfillment of the inflation mandate.

If the markets start to doubt the Fed's independence, the consequence will be... higher rates.

This is especially true given that every time a new Fed chair is appointed, the market always "tests" them. According to an analysis by Bank of America covering the last seven appointments (since Arthur Burns in 1970), rates tend to rise in the three months following the announcement. On average, 2-year rates rise by 65 basis points and 10-year rates by 49 basis points over this period.

Three months after Jerome Powell's appointment, the 2-year rate had risen by 15 basis points and the 10-year rate was up 7 basis points.

For the next Fed chair, the best way to lower rates will therefore be to distance themselves from President Trump and reaffirm the Fed's independence from political power.

The trajectory of interest rates will mainly depend on inflation in the coming months. Inflation is likely to rebound as the impact of tariffs is felt. Tariffs tend to be inflationary. Higher inflation means higher interest rates.

Finally, long-term rates are sensitive to concerns about the deficit. Congress is expected to pass Donald Trump's tax bill this week. According to estimates by the Congressional Budget Office (CBO), the version of the bill passed by the House last month would increase the deficit by $2.8 trillion over 10 years. And the version expected to be passed by the Senate is likely to cost even more.

In short, while Donald Trump spends all day calling for lower interest rates, his communication and actions could well produce the opposite result.

Source: marketscreener

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