What President-Elect Donald Trump Means for Interest Rates

Staff Writer

In the weeks following the election, one thing almost all economists and market watchers agree on is that interest rates are going to rise. That prognostication has little to do with Donald Trump winning the presidency, because interest rates were rising even before the election. The Fed increased the short-term rate in its first meeting following the election, but it was planning on that regardless of who was elected. So, if interest rates are already on the rise, what if anything does the election of Trump portend for interest rates?


Interest Rates Already on the Move


The Fed had been signaling for six months that it would increase the Fed Funds rate by a quarter, so it came as no surprise when it actually pulled the trigger. However, the Fed raised some eyebrows when it stated that it expects three more rate increases over the course of the next year. That’s somewhat surprising because, initially, it had indicated there might be one or two more rate increases. Is it possible that the Fed’s more aggressive stance has something to do with Donald Trump? Hold that thought for a moment.


Just prior to the election, 30-year fixed mortgage rates began to increase for the first time in a couple of years, jumping from 3.4% to just over 4%. That was in response to a spike in the 10-year Treasury yield to its highest level in four years. The spike also moved home equity rates, unsecured loan rates, and credit card rates. At the time, that may have had less to do with the Donald Trump effect and more to do with more pronounced signs that the economy was starting to grow faster. Since the election Treasury yields have continued to increase sending bond prices tumbling down.


The Trump-Effect on Interest Rates


So, the question remains, what effect will Trump’s election have on interest rates going forward? The answer may lie in what happens over the new president’s first 100 days or the next couple of years or however long it takes to see which of his policies are implemented. For now, the stock market seems to be predicting that his policies of lower corporate taxes and fewer regulations will lead to higher corporate earnings.


Future Inflation is the Key


The post-election stock market bounce has also been fueled by a sharp increase in Treasury yields, which may also be reacting to Trump’s pro-growth policies. When the stock market rallies, as it has since Trump’s election, bondholders tend to sell off their bonds. Pro-growth policies can be good for the stock market, but the bond markets may be concerned over the prospect of higher inflation. Bonds don’t perform well during periods of inflation because it has the effect of eroding their value. If bond yields 2.5% and the inflation rate is 3%, the bond is generating a negative return of -0.5%. Investors would be better off putting their money into the stock market, which is what they are doing right now, fueling the market rally.


Should Trump’s pro-growth policies, which also includes $1 trillion in proposed infrastructure spending, work, the economy can be expected to add more jobs at a faster rate. When more jobs are created, it puts upward pressure on wages, which is good for wage earners, but it is also inflationary. Employers have to pay higher wages, which increase their costs and the prices consumers pay for goods. With more dollars swirling around in the economy, the demand for goods increases, driving prices higher.


As the inflation rate rises, bond yields must also rise to make bonds more attractive as an investment. If inflation rises too quickly, the Fed must jump in to cool it down by raising short-term rates. By increasing the cost of borrowing, the Fed hopes that, by increasing rates, it will slow the money in circulation, thereby cooling the rate of inflation.


After several years of hovering between 0 and 1.5%, inflation looks to be heating up again. Economists, including the Fed, are projecting prices to grow by 2.3% over the coming year. That was before Trump was elected. Some economists are now revising their economic projections upward, which could add more fuel to inflationary expectations.


The Fed originally based its two future rate hikes in 2017 on pre-election data. Although the data hasn’t changed much over the last couple of months, the economic outlook has. With the stock market soaring and bond yields spiking, the Fed may now find itself playing catch up with the markets. When the Fed announced its quarter-point increase in December, it then changed its projection of future rate increases from two to a more aggressive stance of three possible increases in 2017.  The Fed may very well be anticipating the Trump-effect on inflation.


What to Expect in 2017


Regardless of who was going to be in the White House in 2017, interest rates are headed higher. The only question is how high they will go and how quickly they will get there. That is where having Donald Trump in the White House might make a difference. If he gets his way with tax reform, deregulation and infrastructure spending, we could see interest rates climb a point or two in anticipation of higher inflation. However, that may not unfold for a year or two. The most reasonable expectation for 2017 is a gradual uptick in the Fed’s short-term rate as promised and a mortgage rates a point higher by summer.