This, by now, ought to be clear to President Trump: He can have high tariffs. Or he can have low interest rates. But he can’t have both.
The problem is that Trump does want both, and he seems to think he can outmuscle or outsmart markets into providing benign business conditions while he riles everything up with tariffs that raise costs and prices. At this point, Trump has tried Maximum Tariff, and markets have responded with Maximum Consequences. The unanswered question now is whether Trump will accept the consequences, which, ironically, would undermine other key parts of his agenda.
If not for Trump, investors would be enjoying a sweet spot in markets and the economy right now. Data giving a read on the pre-tariff economy reveal that inflation — the scourge of the past three years — was heading back to near-normal levels while growth and unemployment held up. That would have been the elusive “soft landing” in which inflation comes down without a recession.
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Inflation in March dropped from 2.8% to 2.4%, close to the Federal Reserve’s target of 2%. “Before the tariff tantrum, both consumer and producer inflation trends were slowing down, not speeding up,” economist David Rosenberg of Rosenberg Research wrote on April 11. “There would have been a time when this would have caused bond yields to plummet.”
Declining inflation, or deflation, usually brings interest rates down for several reasons. It gives the Fed more room to cut short-term rates without worrying about stoking higher prices. It dials down the inflation premium long-term bondholders tend to demand. It can also suggest a slowing economy in which demand falls, lending declines, and the price of money — interest rates — goes lower.
But rates have been rising since Trump went to Maximum Tariff on April 2, the day he announced double-digit tax hikes on imports from dozens of trading partners. Trump dialed those back on April 9 while at the same time pushing the tariff on most Chinese imports to a ruinous 145%. Interest rates continued rising, with the benchmark Treasury jumping from 3.9% on April 4 to 4.5% just a week later.
That’s a big jump in a short period of time, signaling that something disruptive is going on. Economically, markets are deciding that the Trump tariffs will push inflation higher than it would otherwise be, slowing the US economy, lowering the return on US assets, and making other types of investments more attractive by comparison. Rates will have to be higher to draw investors back into US Treasury securities or any other asset linked to the US economy.
Trump, of course, wants the lowest possible interest rates, much as he did as a real estate developer heavily dependent on credit. He has called on the Fed to cut rates as a way to offset the damage his tariffs could cause. In February, Trump’s Treasury secretary, Scott Bessent, said “the president wants lower rates” and was focusing specifically on the 10-year Treasury, which determines the rates on mortgages and most other consumer and business loans.
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If Trump had never launched his trade war, he’d have lower rates — and everybody who borrows would be benefiting from them. “The problem is that Trump’s tariff turmoil is expected to be inflationary,” economist Ed Yardeni of Yardeni Research wrote in an April 14 analysis. “This means that rising inflation likely would delay any Fed easing to avert a recession.”
Markets have now shown that higher tariffs and lower rates are mutually exclusive — as long as the economy is growing and consumer spending is holding up. So Trump has three choices: Stick with his tariffs and accept higher rates, repeal at least some of the tariffs to get rates down, or try to force rates down while keeping tariffs in place.
Markets would cheer if Trump changed his mind about tariffs, but there seems to be little chance of that happening. Trump could accept higher rates and other adverse consequences, and he may have to, eventually. What concerns investors now, however, is that Trump will first try to force rates down through some unorthodox experiment that could blow up even worse than Trump’s protectionist agenda.
One way to fiddle with rates would be for the Treasury Department to issue fewer long-range bonds, such as 10- and 30-year Treasurys, while selling more short-range bills. Janet Yellen did that as Biden’s Treasury secretary starting in 2023, pushing the portion of Treasury debt issued in short-term instruments past the recommended range of 20% to about 22%. Bessent criticized that move then but has continued the policy as Treasury secretary. Raising the portion of short-term bills would mean fewer long-term bonds coming into the market. If demand for bonds remained stable, the lower supply means bond prices would rise and interest rates, correspondingly, would fall.
A more worrisome scenario would be Trump firing Fed Chair Jerome Powell and trying to install a new chair who’d be more willing to cut rates, even if it did stoke inflation. Some Trump critics think he’s preparing to do exactly that, using Powell as a scapegoat for rising rates and installing somebody more likely to take marching orders from Trump.
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Firing Powell could quickly backfire since markets rely upon a central bank seen as apolitical, even if it does make mistakes. A Trump-friendly Fed more eager to cut short-term rates would probably make inflation fears worse because it would suggest that the Fed didn’t particularly care about higher inflation. Short- and long-term rates usually move in the same direction, but they don’t have to, and long-term rates could still go higher if the Fed’s short-term rate cuts threatened higher inflation.
The third way Trump could get long-term rates down would be simply by causing a recession, which might happen whether Trump intends it or not. Goldman Sachs, for instance, raised its recession odds to 65% when Trump announced his April 2 tariffs, then dropped that to 45% after he delayed many of them on April 9. Yet Goldman Sachs, like many other forecasters, thinks US economic growth will still slow toward zero by the end of 2025, leaving little cushion if there’s another unexpected shock or Trump policy mistake.
In a recession, rising unemployment and lost wages usually lead to spending cutbacks and depressed demand. That, in turn, normally brings down prices and alleviates inflation concerns. When combined with short-term cuts by the Fed, that’s more than enough to bring longer-term rates into a zone that would probably make Trump happy — say, a 10-year Treasury rate of 2% or lower, which might correspond with mortgage rates of around 4%.
However Trump tries to get there, he’s taking an awfully circuitous route to lower rates, given that he’d probably have them if only he had never launched his trade war. And it’s not likely to be an enjoyable ride.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Bluesky and X: @rickjnewman.
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