Interest Rate Obstacles Are Bigger for Trump than for Powell

President Donald Trump has made it clear he wants interest rates to come down. But achieving that goal won’t be as simple as replacing Federal Reserve Chair Jerome Powell.

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There are powerful structural forces pushing borrowing costs higher and these forces extend far beyond the Fed’s control. Governments and corporations are accumulating massive debt to finance tax cuts, defense spending, and massive investments in artificial intelligence.

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This growing appetite for credit is met with a shrinking pool of savings as Baby Boomers exit the workforce and China gradually reduces its financial ties with the U.S.

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Any political interference with the Fed’s independence risks making this worse. Global investors rely on a stable, politically insulated central bank to ensure their savings aren’t eroded by inflation. If confidence weakens, the pool of capital available to fund U.S. debt could shrink further.

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Taken together, these dynamics point to a future where 10-year Treasury yields critical for setting rates on mortgages and corporate bonds might settle around 4.5% as a long-term norm. Economics even projects that yields are more likely to climb above this level than fall below it. For the U.S., this represents a dramatic shift after decades of cheap money.

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For over 30 years, borrowing costs steadily declined, allowing Washington to expand its debt without fiscal strain. Easy credit fueled housing booms, equity rallies, and robust consumer spending. That era is over. Today, interest payments on federal debt threaten to surpass defense spending, while mortgage rates near 7% weigh heavily on home prices.

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This reality challenges the idea that simply installing a new Fed chair could solve the problem. Powell does control short-term policy rates, and signs of a softening labor market combined with the upcoming departure of Fed Governor Adriana Kugler opening the door for a Trump appointee make a September rate cut increasingly probable.

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But over the long run, deeper economic forces determine where rates settle. Like any other price, the cost of borrowing is driven by supply and demand: a greater supply of savings pushes rates down, while increased demand for capital drives them higher.

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Economists call the equilibrium that balances savings and investment while maintaining stable inflation and employment the “natural rate of interest.”

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From the early 1980s through the mid-2010s, this natural rate steadily declined. Several factors contributed:

• Ample savings: Baby Boomers were in their prime earning years, saving aggressively for retirement.
• Global capital flows: China’s vast trade surpluses were recycled into U.S. Treasuries to prevent its currency from appreciating. Oil-rich nations like Saudi Arabia did the same with their petrodollar earnings.
• Stable policy: Presidents from Ronald Reagan through Barack Obama respected the Fed’s independence, assuring investors that inflation wouldn’t erode their savings.
• Weaker investment demand: As U.S. productivity growth slowed from 4% in the 1960s to below 2% in the 2000s, fewer profitable opportunities existed for businesses to deploy capital.
• Fiscal restraint: After the Cold War, reduced defense spending and disciplined budgets kept government borrowing low. In 2001, federal debt stood just above 30% of GDP, and the U.S. even ran a budget surplus.
• Tech efficiency: Moore’s Law dramatically lowered computing costs, enabling businesses to invest more efficiently without massive capital outlays.

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The result was an abundance of savings chasing limited investment opportunities, driving long-term real interest rates down from about 5% in the early 1980s to a low of 1.7% by 2012.

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That landscape has now flipped. Retiring Boomers are spending rather than saving. China no longer needs to stockpile dollars, with foreign exchange reserves dropping from nearly $4 trillion in 2014 to $3.3 trillion today.

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Similarly, oil-producing nations are redirecting wealth into ambitious domestic projects like Saudi Arabia’s $1 trillion Neom megacity instead of U.S. bonds.

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Geopolitical tensions have further undermined Treasuries as a safe-haven asset. After the U.S. and its allies froze $300 billion in Russian reserves in 2022, many nations grew wary of keeping their savings in American markets where they could be seized.

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Meanwhile, defense budgets are climbing worldwide. NATO members are raising military spending to 3.5% of GDP, which Bloomberg Economics estimates will add $2.3 trillion to European debt over the next decade. With U.S. debt approaching 100% of GDP, competing borrowing needs will keep rates elevated.

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Bloomberg’s models suggest the natural rate has already risen to 2.5% in 2024 and could reach 2.8% by 2030, keeping 10-year Treasury yields hovering between 4.5% and 5%. If climate change mitigation, AI-driven infrastructure investments, and heightened military outlays accelerate, the natural rate could climb past 4%, sending Treasury yields toward 6% or beyond.

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Trump’s rhetoric against Powell and threats to politicize monetary policy could backfire. A loyalist Fed chair might temporarily cut short-term rates, but undermining the Fed’s credibility as an inflation fighter would drive foreign investors away from U.S. bonds, pushing long-term borrowing costs even higher.

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It’s important to note that estimating the natural rate is complex, with significant uncertainty around both current and future levels. Not every aspect of the low-rate era was positive sluggish growth and limited investment opportunities were hardly ideal. If higher borrowing costs result from AI-driven productivity gains or serious efforts to combat climate change, that would be a healthier reason for rates to rise.

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Still, one thing is clear: after more than 30 years of falling borrowing costs, the trend has reversed. For the U.S. government, Wall Street investors, and everyday Americans managing 401(k)s or shopping for mortgages, this marks a profound transition. And for Trump, it’s a challenge that firing Jerome Powell simply cannot fix.

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