Donald Trump vs Federal Reserve: Why a 1% Fed rate cut could backfire, fuel inflation, and rattle markets — here's what economists say

Time of India

6 hours ago

US President
Donald Trump
's renewed call for the Federal Reserve to slash its benchmark interest rate to 1% in a bid to ease government borrowing costs and finance rising deficits could backfire, according to a detailed Reuters analysis.
Economists warn the move risks inflaming inflation expectations, undermining Fed credibility and triggering a bond market backlash.
Trump, who has championed deficit-financed tax cuts and spending increases under his "One Big Beautiful Bill Act", has suggested that a 1% interest rate would allow his administration to sustain higher government debt without raising borrowing costs.
But analysts argue that such a drastic rate cut — down from the current 4.25–4.50% range — would signal a crisis response in an economy that is still growing steadily, with inflation running at 2.5% and unemployment at 4.1%.
'A Fed policy rate that low is not typically a sign that the US is the 'hottest' country in the world for investment,' the Reuters report noted. Instead, it has historically been associated with economic distress — including the aftermath of the 2001 attacks, the 2008 global financial crisis, and the COVID-19 pandemic.
Gregory Daco, chief economist at EY-Parthenon, warned that slashing rates to 1% under current economic conditions would likely trigger fears that the Fed was bowing to political pressure.
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'The bond market fear would be that inflation would reignite and essentially we would have a loss of Fed independence and a de-anchoring of inflation expectations,' he was quoted as saying.
While there may be some scope to ease rates modestly, a deep cut as Trump demands could erode confidence in the Fed's commitment to its dual mandate — price stability and full employment — especially as inflation remains above target.
The Fed influences borrowing costs through the federal funds rate, but it does not control interest rates on US Treasuries directly. These are determined by global markets, factoring in demand, supply, inflation expectations, and term premiums. Any perception of fiscal indiscipline or political interference could push Treasury yields higher, offsetting any benefits from lower short-term rates.
Trump's push for lower rates comes amid rising US deficits and debt, driven in part by tax cuts and new spending proposals.
The Reuters report notes that the US still enjoys relatively low borrowing costs due to global trust in its institutions and the dollar's safe-haven status — but this trust could erode if market participants perceive a weakening of Fed independence.
Central bankers are also wary of the inflationary risks posed by Trump's new wave of tariffs on major trading partners, including the EU and Mexico. Slashing rates without clear signs of economic slowdown or disinflation could be seen as reckless.
"Exits and repatriation are part of the process and indicates a sign of a mature market," Daco noted, stressing that data does not support a drastic shift in monetary policy.
Trump reportedly sent Fed Chair Jerome Powell a handwritten note with his preferred interest rate penciled in — close to 1%. However, any move by the central bank in that direction without data-based justification could trigger a loss of credibility, higher inflation expectations, and even capital flight, economists warn.
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