The US President wants to replace members of the rate-setting committee with his acolytes, so they can lower interest rates by as much as 3 per cent to bring down the cost of government borrowing. The implications are enormous; a president effectively being in charge of monetary policy would destroy the Fed’s independence, with the markets reacting with horror.
The implications of his tactics are clear to see. On Tuesday US government bonds saw the largest gap between long- and short-term yields for three years. The market’s actions reflect worries that the Fed will cut rates soon due to political pressure but then raise them again later to fight inflation. UK gilts – the cost of British government borrowing, which is in lockstep with the US – followed suit.
According to Capital Economics’ research, the rise in long-term UK gilt yields, if sustained, will reduce Reeves’s headroom from £9.9bn to around £5.3bn. Combined with the need to plug spending U-turns on winter fuel and welfare, alongside potential downward revisions to the Office for Budget Responsibility’s migration and productivity forecasts, it could mean she needs to raise up to £27bn in the Budget.
By Labour’s election victory last July, the 30-year bond yield had risen back over 4.5 per cent, and has climbed since. It has remained above 5 per cent since January, climbing to a 27-year-high on Tuesday of 5.6 per cent after Trump’s fresh attack on the Fed’s independence.
square ECONOMY AnalysisTrump is bringing crony capitalism to America - the USSR would be proud
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Professor Jagjit Chadha, who recently stepped down as head of the National Institute for Economic and Social Research (NIESR), claimed the economy was at risk of “collapse” and told the paper the current financial situation was “as perilous the period leading up to the IMF loan of 1976” when Britain had to be bailed out by the global financing body.
The Chancellor is facing a difficult autumn and is using the end of the summer to float potential tax increases on expensive houses and a raid on pension pots to see how they land with the public. Expect that to carry on into the autumn – right now, Reeves is flying more flags than Horatio Nelson at Trafalgar.
Trump’s aggressive tactics are well-known both at home and on the international stage. The Fed and US Treasury bonds are supposed to be a financial safe haven for global investors. Not any longer.
Trump’s ambitions are far wider. He wants to shake up the entire Fed board and replace it with disciples who share his political outlook; a short-term sugar rush by cutting rates but with an economic hangover that could last years.
What this week’s turbulence in the long-term gilt rates has shown is that Trump can’t outrun the reaction of the international bond markets. And nor can the UK.
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