Trump's Actions Backfire as Interest Rates and Inflation Rise

The yield on 10-year U.S. Treasury bonds has risen to its highest level since 2007, increasing pressure on inflation and long-term interest rates, thereby compressing future policy space.

Written by: Li Jia, Wall Street Journal

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

Nick Timiraos, a well-known financial journalist referred to as the "new Federal Reserve correspondent," 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 combination of tariffs, tax cuts, fiscal spending, immigration restrictions, and energy shocks has led to a deviation in policy effectiveness from the White House's expectations, resulting in greater upward pressure on inflation and long-term interest rates.

The article points out that the yield on 10-year U.S. Treasury bonds has risen to its highest level since 2007, and mortgage rates have also risen from nearly 6% in February back to over 7%. For a new home loan of $400,000, this means an increase of about $3,000 in annual repayments for households. The report suggests that this situation is not entirely caused by external shocks such as conflicts in the Middle East; U.S. fiscal, trade, and labor policies are also contributing to price pressures.

More concerning is that 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 labor supply, energy shocks have raised transportation and production costs, and the AI investment boom has increased demand for funds. Under multiple pressures, the U.S. may face limited policy space to respond to economic downturns in the future.

Why Are Long-Term Interest Rates Rising Despite No Reduction in Fiscal Deficit?

Reports indicate that the Trump administration initially signaled to the bond market that it hoped to restore fiscal discipline by reducing the fiscal deficit, thereby lowering long-term financing costs. Treasury Secretary Mnuchin proposed a "3-3-3" plan, which included reducing the deficit rate to 3%, achieving 3% real economic growth, and increasing domestic energy production equivalent to 3 million barrels of oil per day.

However, while there has been some progress in economic growth and energy output, the fiscal deficit has not improved significantly and remains around 6% of GDP, close to the levels seen during Biden's presidency. Bruce Kasman, chief economist at JPMorgan, stated that based on the performance of the U.S. economy this year, one would expect to see a narrowing of the budget deficit, "but the budget deficit has not decreased."

The article analyzes that the government's continued issuance of large amounts of debt has led investors to reassess the future scale of U.S. financing, inflation risks, and fiscal sustainability, demanding higher long-term yields. Former World Bank President Zoellick believes that Mnuchin's efforts to lower yields through repurchasing old debt are more of a "tactical tool" to respond to 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 U.S. Treasury yields is not solely a result of Federal Reserve policy; it also reflects the market's repricing of the U.S. fiscal outlook.

How Do Tariffs, Immigration, and Energy Shocks Drive Up Inflation?

Regarding inflation, the article suggests that U.S. domestic policies and external energy shocks are creating a cumulative effect.

Reports indicate that Jessica Riedel, a researcher at the Brookings Institution, believes that policies such as tax cuts, new spending, increased tariffs, and pressure on the Federal Reserve to lower interest rates may inherently increase inflationary pressures. Tariffs can raise import costs, potentially leading businesses to pass some of those costs onto consumers. The White House's subsequent reduction of tariffs on certain goods also reflects policy considerations to alleviate cost-of-living pressures.

Immigration restrictions primarily affect prices through labor supply. With the unemployment rate close to 4% and economic demand still resilient, a contraction in labor supply may exacerbate hiring and wage pressures for businesses, further driving up service costs.

Energy shocks are even more direct. Conflicts in the Middle East have driven up oil and diesel prices, with diesel being widely used in agriculture, transportation, construction, and manufacturing. Former Treasury advisor Joseph Lavornia stated that diesel "is the industrial economy," and rising prices may transmit along the supply chain to food, logistics, and retail sectors.

These factors also complicate the policy environment for the Federal Reserve. Trump previously hoped to push for lower interest rates, but rising energy prices and economic resilience have limited the space for rate cuts. Richmond Fed President Barkin believes that if inflation persists, the Federal Reserve will need to take action; some economists also point out that raising interest rates cannot directly address supply-side issues such as diesel prices.

The AI Investment Boom Also Competes for Limited Funds

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

The article further analyzes that both AI company financing and federal government debt issuance require funds. When corporate investment remains strong and government deficits are high, the simultaneous increase in demand for funds may require borrowers to pay higher interest rates to attract investors. The AI investment itself is not the problem, but its expansion alongside high fiscal deficits may prolong the high-interest-rate environment.

The deeper impact lies in policy space. The report points out that if the U.S. economy weakens in the future, declining tax revenues and increasing social spending may further widen the fiscal deficit; if the market simultaneously worries 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 around 7% weaken purchasing power and also deter many homeowners with locked-in low-rate loans from selling, further limiting housing supply. Former White House Council of Economic Advisers acting chair Pierre Yared believes that the issue of housing affordability is related to years of accumulated price increases and is also constrained by insufficient housing supply.

Overall, the article concludes that the current high inflation and high interest rates in the U.S. are the result of the combined effects of fiscal deficits, tariffs, labor supply, energy prices, and AI investments. The article emphasizes that if this pattern continues, it may further compress the policy space for the U.S. to respond to economic downturns in the future.

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