Markets are getting increasingly rattled by the difficulty of understanding what Donald Trump is likely to do next, but this should not have come as a surprise.
Trump’s great skill as a politician is his ability to convince so many people that he will be good for them, even though his policies are clearly contradictory, and there’s no sound reason for thinking that he’ll stick with the ones they particularly like. You struggle to pick out any consistent ideology other than a belief that the president’s power should be unchecked.
So we shouldn’t put too much weight on any forecasts for the next few years because they are even more guesswork than usual. Still, there is one big risk that we should not underprice: Trump forcing through a very large cut in interest rates.
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Unusually consistent
It is entirely clear from Trump’s career that he will always favour lower interest rates – this is one of the rare situations where his comments and his conduct are almost always consistent.
After all, he does not fit the profile of anybody who believes in sound money. He is a real-estate developer with a history of borrowing as much as he can, and of filing business bankruptcy or getting debt forgiveness from lenders on several occasions.
Back in 2016, when first running as president, Trump accused the Fed of keeping rates too low to help Barack Obama, saying it had created a “false economy”. Once in power, that changed.
In 2018, after the central bank started to raise rates, he criticised it for moving too fast and called it his “biggest threat”.
This time, he said throughout his election campaign that rates should be lower, and he’s been stepping up that pressure since he got back in the White House.
Will the Fed cave under pressure?
The Fed is nominally independent but not immune to political pressure. It will cave in to this, just as it did in 2019.
The natural assumption is that the governors are moderately responsible, so they will give Trump lower rates, but not recklessly so (by their easy-money standards).
Yet, if the US economy starts to weaken and Trump’s approval ratings follow it down, it is very plausible that he will demand much deeper cuts.
The highest rates got in his last term was 2.5%, and much of the time, they were zero.
Would the current governors agree to that? That might not matter – Trump could try to replace them if they did not.
Fed chair Jerome Powell has said he won’t step down, and the president is not allowed to fire him. But given the approach that Trump is taking on other issues, I would take very little comfort in any legal arguments as to why he can’t replace the entire board with himself, Elon Musk or whoever else happens to be in favour.
If rates were cut aggressively, the usual tactic would be to hold long-term bonds (their price moves more for a given change in rates).
Yet, if Trump coerces the Fed, it could rattle markets even more, causing the yield curve to steepen.
I do not expect this to play out unless the US economy weakens severely, but it is another reason why our strategic portfolio holds only short-term bonds. Long-term yields are not high enough for this risk.
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