Donald Trump’s bully boy tactics to try to force the Federal Reserve into cutting interest rates is bad news for the US in the long term. But it’s also a headache for Rachel Reeves – and British taxpayers.
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.
Trump’s gambits are hard to watch. He’s already tried insults to get rid of board members he doesn’t like. He dubbed Fed chief Jerome Powell a “moron,” a “numbskull” and “stubborn mule” for declining to drop rates. Now he’s moved to fire Fed governor Lisa Cook and accused her of lying on a mortgage application, a clear attempt to destroy her credibility. Cook, bravely, is refusing to back down, saying Trump does not have the authority to sack her.
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.
“The bullying of the Fed is pushing up government borrowing rates in the US and also by extension is pushing up government borrowing rates in the UK, as those rates tend to track each other. The obvious immediate implication is for the Autumn Budget; it raises borrowing costs the for the government, so it eats into the fiscal headroom and means they have less wiggle room,” Thomas Ryan, North America economist at Capital Economics, told The i Paper.
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.
Prior to former Conservative prime minister’s Liz Truss’s election in 2022, the UK’s 30-year bond yield was roughly 2.4 per cent. After her disastrous mini-Budget the 30-year bond yield jumped to 5 per cent, before falling back to about 3.5 per cent after many of her measures were reversed.
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.
On Tuesday Reform UK leader Nigel Farage even referenced the UK’s 30-year-gilt rate to suggest the Government may collapse in advance of the next general election, a monumental piece of spin greeted by cheers from his supporters, overexcited by reports in The Sunday Telegraph that Reeves may have to go cap-in-hand to the International Monetary Fund.
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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.
But NIESR is at the gloom-mongering end of economic think-tanks, claiming in August an extra £50bn a year is needed for public investment to secure long-term economic prosperity, a figure considered exaggerated by other economists. For instance, Thomas Pugh, UK economist at accountants RSM, puts the figure at £20bn.
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.
But it’s not all doom and gloom for Reeves. Earlier estimates of the UK’s growth measured by gross domestic product have been revised upwards. Consumer confidence is growing after interest rate cuts. Meanwhile the hiring slowdown in hospitality and retail sectors caused by the rise in employers’ national insurance contributions seems to be levelling off and wages are growing faster than inflation.
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.
No sensible person wants to go back to the days of presidential spats with the Fed board. In 1965 president Lyndon Johnson famously shoved his Fed chair William McChesney Martin against a wall during an argument about rates.
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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