Trump inherits a solid economy that makes it harder to lower borrowing costs or inflation
Trump inherits a solid economy that makes it harder to lower borrowing costs or inflation
WASHINGTON (AP) — President Donald Trump has promised lower prices and lower interest rates, but an economy transformed by the pandemic will make those promises difficult to keep.
Economic growth is solid, driven by healthy consumer spending. The budget deficit is huge and could get even bigger. At the same time, businesses are increasing borrowing to invest in data centers and artificial intelligence, leading to increased demand for loans that carry higher interest rates.
If Trump follows through on his pledge to impose broad tariffs on imports and deport millions of immigrants, economists expect inflation could worsen — making a sharp rate cut by the Federal Reserve this year less likely.
All of these trends could lead to higher borrowing costs, including for homes and cars.
However, on Thursday during the World Economic Forum's annual event in Davos, Switzerland, Trump said, “I will demand that interest rates be lowered immediately, and likewise, interest rates should be lowered around the world,” without providing further details.
The biggest reason borrowing costs are likely to remain higher is that the economy has shown surprising resilience after the upheaval of the pandemic, with trillions of dollars in government fiscal support from Trump and former President Joe Biden, soaring inflation, and several concerns about recession.
Jan Hatzius, chief economist at Goldman Sachs, said the economy is “in a prime position for healthy growth.”
Annual growth has been at least 3% in four of the last five quarters, the longest streak in a decade. The unemployment rate is at a record low of 4.1%. Inflation surged to a 40-year high in 2022, leaving most Americans dissatisfied with the economy, but has now fallen back to 2.4%, according to the Fed's preferred measure.
Wages will lag prices badly in 2021 and 2022, but have grown faster than inflation over the past 18 months, providing the impetus needed for continued growth.
A healthier economy encourages more Americans to borrow money to buy cars, homes and major appliances, and for businesses to invest in IT equipment and factories. These moves are good for the economy, but more demand for loans to fund all spending can also lead to higher interest rates.
More stable growth could push prices higher. Companies that see healthy consumer demand may decide to charge higher fees, like Netflix announced after a surge in subscribers.
This trend has changed dramatically from the last time Trump won the White House in 2017. At the time, the U.S. economy was slowly emerging from a long period of sluggish growth and very low inflation that followed the painful Great Recession of 2008-2009. Millions of households have curbed spending and boosted savings after a borrowing binge in the early 2000s led to a rise in mortgage and credit card debt.
“Household balance sheets are shrinking relative to income, which is a very important deflationary force that's not there yet,” said Julia Coronado, president of Macro Policy Outlook and a former Fed economist.
Today, most households have less debt, and upper-income households in particular have benefited from strong gains in home values and stock market wealth. About 40% of homes are now free and clear – no mortgage needed. Greater wealth could spur continued spending on travel, electronics and dining out.
In addition, high-tech companies are increasing investment in data centers to accelerate the development of artificial intelligence. Trump announced on Tuesday a joint venture between OpenAI, Oracle and Japan's SoftBank to invest $500 billion in data centers and power generation to promote artificial intelligence research. Before the pandemic, many companies were hoarding cash but not investing as much, which could keep interest rates low.
“We're in a different world,” said Joe Brusuelas, chief economist at RSM, a tax advisory and advisory firm. “Gone are the days of low inflation and low interest rates. In their place is a new framework characterized by scarce capital and higher interest rates.”
As a result, Trump has promised to stimulate the economy through tax cuts and deregulation, while also promising tariffs and immigration restrictions that could lead to higher prices.
“This will stoke inflation and prompt Fed policymakers to adopt more restrictive policy than they would otherwise,” said Gregory Daco, chief economist at EY. “So you're going to be in a higher interest rate environment.”
Trump is seeking to promote more oil and gas production in the United States to lower energy prices and reduce broader inflation. This, in turn, would allow the Federal Reserve to lower its key interest rate.
But that doesn't take into account the reaction of financial markets, which also affects the cost of borrowing a house or a car. The yield on the 10-year Treasury note, which has a major impact on mortgage rates, has actually risen sharply since the Federal Reserve began lowering key interest rates in September.
Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, said investors expect the economy to continue to grow strongly, in part because of Trump's tax cuts and deregulatory proposals. In this case, the Fed is less likely to cut key interest rates.
Many investors are unimpressed by Trump's tariff threats, hoping he intends to use them as bargaining chips in international negotiations rather than impose them permanently.
“I think there’s an expectation that President Trump will bring all the good policies and leave all the bad policies that promote growth aside,” Goldberg said.
Another trend spurred by Trump's push is the rise of protectionist measures around the world after two decades of globalization. That has left multinational companies scrambling to shift production away from countries targeted by Trump's ire, especially China, to other countries such as Vietnam or Malaysia.
“Globalization is not driving down prices, or at least limiting them, we are now reshuffling supply chains and protectionist barriers are rising,” Brussulas said. Almost all economists predict this will push prices higher, although the increase may be modest.
In another twist, high annual budget deficits could also cause interest rates to rise, as Wall Street investors may demand higher yields to buy all the Treasuries needed to finance the debt.
Last week, the nonpartisan Congressional Budget Office said the deficit could hit $1.9 trillion this year and rise to $2.7 trillion within a decade. Trump's proposals to extend the 2017 tax cuts and implement new tax cuts, such as eliminating the tip tax, could further increase the deficit.
“If we don't lower the fiscal deficit, we're going to see long-term bond yields rise. That's what we're starting to see,” Fed Governor Chris Waller said earlier this month.
