What The Trump Administration Gets Wrong About the Fed, Interest Rates, and Inflation

One of my early morning habits is drinking coffee while reading the Wall Street Journal’s “The 10-Point” email newsletter and possibly a few other things in my news feed related to business and the economy.

Of recent interest was CNBC’s reporting of a press conference held by Vice President JD Vance with his comments that show he, and likely his boss, President Trump, don’t understand the interplay of the US Federal Reserve (the Fed), interest rates, inflation, and mortgages.

Quoting the article:

“’One of the main reasons he cares a lot about interest rates is because he wants Americans to be able to afford a home,’ Vance said, referencing Trump. ‘When interest rates go higher, that means that borrowing costs are higher.

‘We believe that the Fed should be lowering interest rates,’ he said, calling it the ‘proper and responsible’ response to recent U.S. inflation data.”

Americans generally trust Republicans to manage the economy, but given this quote, that trust may be misplaced.

Anyone who periodically reads the Journal, Barron’s, or any other reputable business news outlet would recognize the core mistake in Mr. Vance’s argument, and it could be he is trying to tie together inflation and mortgage rates to show he’s in touch with the American people. He is speaking to key concerns, and I get that.

The Fed only sets short-term interest rates, and the invisible hand of financial markets set mortgage rates.

In the current economic environment of heavy US debt and accelerated government borrowing worldwide, if the Fed were to lower short-term rates before inflation cools, long-term rates would either not be affected, or, in fact, might go up.

It is generally accepted economic theory that the Fed’s short-term rates must be higher than the rate of inflation to reduce it. This is known as the Taylor rule.

The primary criticism of former Fed Chair Jerome Powell is the Fed didn’t raise short-term rates quickly enough to curb accelerating inflation during the COVID pandemic.

By most measures, inflation is a little more than 3% per year, and unsurprisingly the Fed’s current short-term rate range is 3.5% to 3.75%.

The Fed’s rates are reflected in the most recent no-hassle interest rate on high-yield savings accounts of about 4%, brokerage cash sweep accounts paying from 3.3% to 3.6%, and the four-week Treasury bill offering 3.7%.

The Fed doesn’t set these short-term rates directly, but its rate range heavily influences them.

What Mr. Vance got wrong is mortgages are largely tied to the 10-year Treasury note, which is currently about 4.8%.

The reason mortgages are tied to the 10-year Treasury is because most are paid off in seven to 10 years, either through selling the home, refinancing, or complete amortization of the loan ahead of schedule.

The 10-year Treasury is the risk-free benchmark against which mortgages are judged because the US government has always paid its obligations. Other more risky investments must compensate the investor with more return.

A mortgage company or bank will compare the 10-year Treasury return to what it can make on a mortgage and adjust the rate based on added risk.

Individual mortgagers are seen as greater risk because some of them default, even with thorough underwriting.

Current mortgage rates are 6.7% nationally, about 2% more than the 10-year Treasury. The spread bakes in all the risks associated with mortgage lending.

As already stated, the 10-year Treasury is set by the market, not the Fed. The US Treasury funds government debt by holding auctions of different maturities of bonds, and the investors that buy the bonds take a look at general economic conditions and what they could get paid elsewhere, evaluating risk and reward.

The risk-reward judgement must include the sheer amount of indebtedness of the US government, which just crossed the $40-trillion mark in late August or about $114,000 per person in the US, and the interest to service the debt, currently more than $1-trillion per year, placing it higher than US military expenditures.

As a side note, the high level of US government borrowing to fund out-of-control budgets also crowds out organizations that want to fund more productive uses such as business expansions, and ensures even if they do secure funding, they pay higher interest rates.

The national debt only took 10 years to double from $20-trillion in 2016, and politicians have shown very little reluctance to cut spending, raise taxes, or both to tackle it.

The bond investors who buy 10-year Treasurys may ask themselves how much longer and to what extent they can trust the US government to pay its obligations.

The higher interest rates that bond investors are demanding also relate to the Trump Administration’s relative lack of success with reducing inflation.

If inflation stays at 3% or more, the value of what investors loan the US government erodes over time, and if they don’t think the administration is serious about fighting inflation, they’ll demand even higher interest rates, just like bankers do with loans they extend to you and me.

Jawboning the Fed may look productive as the American people see it as doing something, but it harms the administration long term.

Possibly the administration wants to maintain elevated inflation. It would not be the first time the US or any country used inflation to reduce the relative value of its debt, but inflation hurts consumers, savers, those on fixed income, and lenders.

The Baby Boom generation has seen meaningfully steep inflation twice in their lives; first in the 1970s when they were in the early years of their careers, and post-COVID, right before many of them start retiring- critical periods in most people’s lives. I do not envy them.

I believe current Fed Chair Kevin Warsh is committed to combatting inflation, but the administration’s broader policy choices, tariffs and a destabilizing foreign war, work against this goal.

Tariffs are a tax on imported goods paid by the recipient at the time of arrival, and while many of the businesses that buy those goods have been absorbing the costs when they can, much of the increase has been borne by the consumers of the finished products, meaning you and me. The increase in prices is inflation.

The tariffs would be a relatively simple fix. The administration should work with its economic advisors to determine tariff levels that meet a variety of policy goals and then adjust only as needed with a bias to leaving them alone.

Leaving tariffs alone creates a predictable business environment and lets companies focus on their customers and growth rather than diverting resources to managing the next new round of capricious and arbitrary tariffs.

The Iran war is a tougher fix. Things are already broken, and the war appears to be a stalemate right now. Both cessation and escalation of hostilities have greater risks than maintaining the status quo so the administration is stuck.

The Iran war of course has affected energy prices.

West Texas Intermediate Crude Oil is $90 per barrel so I anticipate we’ll continue to see gasoline around $4.00 per gallon in Georgia for the foreseeable future, subject to seasonal fluctuations. We were paying less than $3 per gallon in March. That’s a 33% increase, quite a shock for anyone who depends on stable gas prices.

Given that petroleum is an input to manufactured products, especially plastics and fertilizers, and that just about everything consumers buy is transported on a truck that uses diesel fuel, gasoline isn’t the only thing affected.

Energy prices illustrate why inflation remains sticky, complicating the Fed’s job further.

The economic growth we saw in the 1980s, post Great Recession, and post COVID has come at the expense of higher government borrowing.

I miss the focus and policies of the Clinton Administration; everything wasn’t perfect, but progress was made towards a balanced federal budget and paying down the US national debt, which happened from 1998 to 2001 through bipartisan work- maybe the last truly significant piece of bipartisan work other than declaring a war.

During the Clinton years there were no foreign interventionist wars that were completely debt financed and added to the national debt to the tune of trillions of dollars.

Had President Bush asked after 9/11 if raising taxes to pay for the wars in Iraq and Afghanistan were OK, many Americans would have been less enthusiastic, or, at least, asked for stronger proof that Iraq had Weapons of Mass Destruction.

The Trump Administration owes the American people honesty about what drives mortgage rates and inflation. Lowering the Fed’s short‑term policy rate will not make homes more affordable when long‑term Treasury yields are elevated, and even if the Fed cuts rates, they may still increase for reasons listed above.

Mortgage rates fall when markets trust that inflation will stay low and that the federal government is committed to fiscal discipline.

Lowering inflation requires a two‑front strategy. The monetary side belongs to the Fed, which must be allowed to do its job without political pressure to cut rates prematurely. The fiscal side belongs to the administration and Congress, who must confront the drivers of inflation they directly control: tariffs, deficit‑financed spending, and the costs of foreign wars.

We have done this before. In the late 1990s, the Clinton Administration and a bipartisan Congress produced budget surpluses and began paying down the national debt. Long‑term Treasury rates fell, mortgage rates followed, and the economy grew without the inflationary pressures we see today. It was not perfect, but it demonstrated that disciplined fiscal policy and an independent Fed can work together to create stable prices, lower borrowing costs, and an affordable housing market.

If the administration is serious about helping Americans purchase homes, it should start by acknowledging the real causes of high mortgage rates, commit to reducing inflation through coherent fiscal policy, and let the Fed operate independently. Anything less is political messaging masquerading as economic strategy.