After the dismal July jobs report, President Trump has doubled down on his efforts to pressure the Federal Reserve to lower its target overnight interest rate (FFR).
Two of his proxies on the Federal Open Market Committee (FOMC), Chris Waller and Michelle Bowman, dissented from the FOMC’s decision to leave the Fed’s target FFR unchanged. And his recent appointment of Stephen Miron to replace Adriana Kugler move the Fed more in President Trump’s direction. But even if Trump gets the interest rate target cuts he has been lobbying for, it likely won’t satisfy him.
That’s because he, and many others, are actually concerned about interest rates other than the one that the Federal Reserve sets. Mortgage rates and corporate borrowing rates are tied to the 10-year Treasury bond rate – which also happens to be an important interest rate for the cost of federal government borrowing. While lowering the short-term rate seems like it would put downward pressure on the 10-year rate, this is not necessarily the case. In fact, the FFR is 1 percent lower than a year ago, while the 10-year is .2 percent higher than a year ago.
The 10-year interest rate has not declined because the large increase in government bond supply—driven by high Congressional spending—pushes rates upward. The supply must decrease or the demand must increase for 10-year bonds before the 10-year interest rate will fall. If Congress were to slash the budget deficit, the 10-year rate would fall on the expectation that the future supply of 10-year Treasury bonds will diminish.
Or if stablecoin adoption continues to grow, fueling greater demand for government debt, the 10-year rate could fall. But lowering the FFR by itself won’t lower the 10-year. In fact, it could push it higher if investors fear that the Fed has caved to political pressure and will generate higher inflation in the future.
But there is another avenue to artificially lower the 10-year rate that Trump has not pushed yet. That avenue entails the Federal Reserve buying longer-term US debt. This has been done before by the Fed under Chairman Bernanke’s Quantitative Easing (QE) programs. It was called Operation Twist. In 2011, the Federal Reserve sold about $400 billion of short-term government debt and replaced it with long-term government debt in order to drive down long-term interest rates.
While this program successfully repressed longer-term interest rates, one can question the merits of such a policy. After all, lowering the cost of federal borrowing made it easier for Congress to run up the debt. With average interest rates on the national debt ranging from about 1.8 percent in 2016 to 2.5 percent in 2019, and then from 1.5 percent in 2020 to 1.6 percent in 2021, the interest cost of debt was small, and the federal government rapidly ran up its tab.
That changed abruptly when the Fed raised short-term rates to combat inflation. The market also raised longer-term interest rates in response to higher inflation. And so the U. S. debt service rose from $16 billion in interest per trillion of national debt in 2021 to $33 billion in interest per trillion of national debt in 2024.
And with growing debt principal ($28.4 trillion on Sep. 30, 2021 vs. $35.5 trillion on Sep. 30, 2024), interest payments on the debt rose from approximately $454.4 billion at the end of fiscal year 2021 to $1,171.5 billion in fiscal year 2024; a debt servicing burden roughly two and a half times greater than three years earlier and more than any other line item except Social Security in the federal budget.
Obviously, President Trump and everyone else in Washington would love to see debt service costs return to $16 billion per trillion in debt – creating a “savings” of over $600 billion a year. But would they cut other government spending and the federal deficit should such interest “savings” materialize? Not likely! In fact, they would almost certainly use it as an excuse to increase spending for other programs.
One of the dangers of the FOMC caving to Trump’s pressure to lower the FFR is that he will almost certainly push them to engage in an Operation Twist-style bond-buying program if the 10-year rate fails to fall; and it likely won’t, given that we have trillion-dollar deficits as far as the eye can see.
Were President Trump to really gain control of Fed policy, we would see monetary policy shift to accommodate the short-term desires and interests of politicians, not the well-being of citizens under a relatively stable monetary regime.
Trump and his allies claim that lowering interest rates will help them reduce the deficit. While that is true all else equal, the claim would be far more compelling if Congress and the White House had chosen to reduce non-interest outlays substantially with the Big, Beautiful Bill. Instead, they hardly cut overall spending at all. Yet cutting government spending on programs and departments would reduce the deficit and reduce the interest cost of federal borrowing, too.
That’s a far better strategy for restoring fiscal sanity than jaw-boning the Federal Reserve. Playing games with the central bank and creating new currency to finance irresponsible deficit spending is the practice of struggling third-world countries. As the wealthiest nation in the world, we should ask more of our leaders and of our central bank officials.
