President Trump is still mad about rising interest rates. He blames the Federal Reserve, which he says is the “biggest threat” to his success. He’s worried they’re raising interest rates too fast, in a way that will unnecessarily slow the economy, because they’re concerned about a phantom inflation threat.
This isn’t a crazy fear. Higher rates do make it more expensive for businesses and consumers to invest, and experts disagree on how much the Fed really needs to raise rates to stave off excessive inflation.
I wrote last week that Trump should blame himself for the higher rates — after all, he nominated Fed Chairman Jay Powell, whose monetary policy views were known and are consistent with the Fed’s path of moderate rate hikes since he took the job. Trump also imposed fiscal policies, like the big tax cut, that were likely to push the Fed toward higher rates.
But taking a step back, Trump doesn’t need to blame anyone for higher rates, because there is a good-news story he can tell about them. Rates are rising because the economy under Trump is strong. Really. Instead of blaming himself for the higher rates, he can take credit for them.
Let me first define what I’m talking about here. The federal government finances itself by issuing bonds with durations anywhere from 4 weeks to 30 years. These bonds pay a fixed interest rate, and typically the longer the bond, the higher the interest rate. There are a few reasons for that, but a big one is that the buyer of a long-term bond takes on the risk that the interest-rate environment will change, and he or she will be stuck collecting an unfavorable rate for 10 years or 30 years.
Interest rates have been on a decades-long downward trend, and the Fed cut short-term rates to near zero during the financial crisis and kept them there for years after. It also took extraordinary steps to lower long-term interest rates. But as the economy has continued to improve, the Fed is now taking steps to “normalize” and get rates back up.
To that end, over the last two years the Federal Reserve has gradually raised interest rates on short-term bonds. It does this by buying and selling bonds on the open market, and by changing the rules about the short-term deposits banks make at the Federal Reserve.
In general, the Fed does not play directly in the market for long-term bonds, though it did so extensively after the financial crisis through its quantitative easing programs, when it bought them in huge quantities as part of an effort to push down long-term rates.
Usually, the Fed exerts its influence over long-term interest rates through the guidance it gives about its future actions regarding short-term interest rates. If the Fed sends credible signals that it will set short-term interest rates higher in the future, that should tend to push private investors trading long-term bonds on the open market to move rates higher. Why? Because if long-term rates didn’t rise, those investors might as well invest in short-term bonds, expecting to collect higher rates when the Fed follows through on its signal that it will raise short rates later.
This expectations-based system of influence looks effective lately — the Fed is hiking short-term rates and rates are rising at all bond durations — and that’s what has the president so upset: Higher rates make it more expensive for businesses to borrow to make capital investments, or for consumers to get home mortgages. All things being equal, that might slow down the economy.
But why do market participants believe the Fed will stick to higher rates? As Neil Irwin notes in the New York Times, the market doesn’t always believe the Fed, and at first, the Fed’s hikes in short-term rates weren’t matched by long-term rate increases. That may have been because bond investors were worried the Fed would face economic pressure to cut rates again in the future: For example, a recession might require monetary stimulus through lower rates.
But now the markets have bought into the rate-hike program, and the rise in long-term rates has actually somewhat outpaced the Fed’s hikes in short-term rates. That looks like a signal of economic confidence: The economy will be strong enough for long enough that the Fed will be able to stick with a program of higher rates.
To put that in practical terms: When the economy is strong, lots of investments look appealing. A business that builds a new factory can expect to earn higher profits from it; a consumer considering a new house or car expects to earn enough income to afford it. That condition supports business and consumer borrowing even in a higher interest-rate environment.
The strong economy also supports the higher interest-rate environment itself: In a strong economic environment, a lender needs to earn a higher interest rate to justify being a lender at all, instead of using capital to make one of the many appealing equity investments that is available. And buyers of Treasury bonds are lenders: When stocks are a very appealing investment, they will tend to demand higher interest rates to stay in bonds.
The Fed isn’t pushing interest rates up all by itself. Long-term rates wouldn’t be rising so much if investors weren’t confident there would be borrowers willing to pay higher rates because they are so eager to invest.
All of which is to say, there is an easy way for Trump to brag about higher interest rates. Rates are high, he can say, because the economy is good and investors have become convinced it will stay good for a while. He won’t even be lying.