"The New Fed Watch": Trump's actions backfired, with interest rates and inflation rising instead of falling.

The Trump administration attempted to improve the growth outlook through a mix of policies, but reality has gradually deviated from the White House's expectations.

Nick Timiraos, a well-known financial journalist dubbed the "new Fed mouthpiece," recently wrote in The Wall Street Journal that the Trump administration originally hoped to improve the financing environment by controlling the deficit, expanding energy supply, and promoting economic growth. However, the combined effects of tariffs, tax cuts, fiscal spending, immigration restrictions, and energy shocks have led to a deviation from the White House's expectations, and inflation and long-term interest rates are facing greater upward pressure.

The article points out that the 10-year US Treasury yield has risen to its highest level since 2007, and mortgage rates have rebounded from nearly 6% in February to above 7%. For a $400,000 new home loan, this means a family's annual repayments will increase by approximately $3,000. The report argues that this situation is not entirely caused by external shocks such as the Middle East conflict; US fiscal, trade, and labor policies are also increasing price pressures.

More importantly, this round of high inflation and high interest rates is not caused by a single factor: the fiscal deficit has not narrowed significantly, tariffs have increased import costs, immigration restrictions have reduced the labor supply, energy shocks have pushed up transportation and production costs, and the AI investment boom has increased the demand for funds. Under the combined pressure of these multiple factors, the United States' policy space for dealing with future economic downturns may also be limited.

Why are long-term interest rates rising despite the fiscal deficit not decreasing?

The report states that early in his presidency, the Trump administration signaled to the bond market its desire to restore fiscal discipline by reducing the fiscal deficit, thereby lowering long-term financing costs. Treasury Secretary Bessant's proposed "3-3-3" plan included reducing the deficit ratio to 3%, achieving 3% real economic growth, and increasing domestic energy production by the equivalent of 3 million barrels of oil per day.

While economic growth and energy output have made some progress, the fiscal deficit has not improved significantly, currently remaining at about 6% of GDP, close to levels seen during Biden's administration. JPMorgan Chase chief economist Bruce Kasman stated that based on this year's U.S. economic performance, a narrowing budget deficit should have been expected, "but the budget deficit has not decreased."

The article analyzes that the government's continued large-scale debt issuance has forced investors to reassess the future scale of US financing, inflation risks, and fiscal sustainability, demanding higher long-term yields. Former World Bank President Robert Zoellick believes that Bessant's methods of lowering yields through repurchasing old debt are more like "tactical tools" to manage the market, but the real determinants of long-term interest rates remain policy variables such as deficit spending and tariffs.

Therefore, the rise in long-term US Treasury yields is not only a result of the Federal Reserve's policies, but also reflects the market's repricing of the US fiscal outlook.

How can tariffs, immigration, and energy shocks drive up inflation?

Regarding inflation, the article argues that domestic policies in the United States and external energy shocks are creating a combined effect.

The report states that Jessica Riddell, a budget and tax researcher at the Brookings Institution, believes that policy directions such as tax cuts, increased spending, higher tariffs, and pressure on the Federal Reserve to cut interest rates could themselves increase inflationary pressures. Tariffs, by raising import costs, may encourage businesses to pass some of those costs on to consumers. The White House's subsequent reduction of tariffs on some goods also reflects policy considerations aimed at alleviating cost-of-living pressures.

Immigration restrictions primarily affect prices through labor supply. With the unemployment rate nearing 4% and economic demand remaining resilient, a contraction in labor supply could exacerbate hiring and wage pressures on businesses, further driving up service costs.

The energy impact is even more direct. The Middle East conflict has driven up oil and diesel prices, with diesel widely used in agriculture, transportation, construction, and manufacturing. Former Treasury advisor Joseph Lavonia stated that diesel "is the industrial economy," and price increases could be passed down through the supply chain to sectors such as food, logistics, and retail.

These factors have also created a more complex policy environment for the Federal Reserve. Trump previously favored lower interest rates, but rising energy prices and economic resilience have limited the scope for rate cuts. Richmond Fed President Barkin believes that if inflation persists, the Fed will need to take action; some economists also point out that raising interest rates cannot directly solve supply-side problems such as diesel prices.

The AI investment boom is also leading to competition for limited funds.

The report also considers the AI investment boom a significant variable affecting interest rates. The White House hopes that AI infrastructure development will drive investment in chips, power equipment, data centers, and manufacturing, but this round of capital expenditure is also increasing the demand for funds, equipment, and electricity.

The article further analyzes that both AI companies need funding for financing and the federal government needs to issue bonds. When corporate investment remains strong and the government deficit is high, the demand for funds increases simultaneously, and borrowers may need to pay higher interest rates to attract investors. AI investment itself is not the problem, but its simultaneous expansion with a high fiscal deficit could prolong the high-interest-rate environment.

The deeper implications lie in policy space. The report points out that if the US economy weakens in the future, declining tax revenues and increased social spending could further expand the fiscal deficit; if the market is also concerned about government financing pressures, long-term interest rates may not fall as significantly as in the past.

The housing market has already reflected this pressure. Mortgage rates of around 7% have weakened purchasing power and discouraged many homeowners with locked-in low-interest loans from selling, further restricting housing supply. Pierre Yard, former acting chairman of the White House Council of Economic Advisers, believes that the housing affordability problem is related to both years of accumulated price increases and insufficient housing supply.

Overall, the article argues that the current high inflation and high interest rates in the United States are the result of a combination of factors, including fiscal deficits, tariffs, labor supply, energy prices, and AI investment. The article is more concerned that if this pattern continues, it could further reduce the US's policy space for dealing with future economic downturns.

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