The Big Economic Question for Trump: Why Are Interest Rates Falling?

His Treasury Secretary is taking an early victory lap over falling mortgage and bond rates, but the reason for the fall will determine whether this is a political success.

Dear readers,

Tomorrow night, President Trump will be addressing a joint session of Congress, and on Wednesday morning, I’ll be recording a podcast with Ben Dreyfuss and Megan McArdle reacting to it. We also intend to answer some of your questions — whether about the speech or other matters. If you’d like us to consider your question, please send it to mayo@joshbarro.com before 8am Eastern on Wednesday.

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Less than two months into his term, voters say President Trump has been insufficiently focused on inflation and the economy, their top concerns, and they perceive him to be overly focused on other issues that have been heavily in the news, particularly the federal workforce and the US-Mexico border. That’s according to CBS/YouGov polling, and that disconnect was the first question Margaret Brennan asked Treasury Secretary Scott Bessent on Sunday on CBS’s Face The Nation.

Bessent responded by arguing that even though Trump has only been in office a few weeks, progress on the economy has already begun. He says the Trump administration is already unwinding the conditions of elevated inflation and interest rates that arose under President Biden:

What we had was a demand shock from the government spending that was met by supply constraints, with over-regulation. So we are in the process of deregulating, which will free the supply side, and we are cutting back the government spending. It took four years to get us here. President Trump has been in office five weeks, and I can tell you, we're working every day. What I will point out, interest rates — the 10-year bond, which I am focused on, has been down every week since President Trump was president. Mortgage rates have been down every week. So that's a pretty good start.

Bessent is right about the signs associated with the various policies he discusses. In current economic conditions, government spending cuts are disinflationary. So is deregulation. If you take upward pressure off inflation, you create space for the Federal Reserve to cut interest rates and keep them lower, so these policies should produce favorable effects on both inflation and interest rates. But Trump has also proposed inflationary policies: He wants to not only extend the 2017 tax law but also add new tax cuts, like a further reduction in the corporate income tax and “no tax on tips,” and he wants new spending in certain areas, including border security. He also has imposed tariffs on Chinese exports, and on steel and aluminum, and keeps threatening more tariffs. The effect of tariffs on inflation is unclear: tariffs raise the price of the tariffed goods, but like any tax increase, they reduce aggregate demand and so they may cause offsetting declines in the prices of other goods and services.

A key question is why long-term interest rates have been falling over the last few weeks. Long-term rates are forward-looking: they reflect market participants’ expectations about future economic conditions, including future monetary policy, fiscal policy, and inflation. As such, they’re influenced not just by what policy the administration is making, but also by what policy it’s expected to make.

U.S. President Donald Trump, joined by then-Commerce Secretary nominee Howard Lutnick, held up an executive order imposing tariffs on steel imports after signing the order in the Oval Office at the White House on February 10, 2025 in Washington, DC. Trump announced a 25 percent tariff on all foreign steel and aluminum imports into the United States. (Photo by Andrew Harnik/Getty Images)

And over the last few weeks, some signs have emerged that Trump’s policies are likely to be less inflationary than previously expected. DOGE has certainly gone harder than I thought it would. And as Congress has gotten to work on a fiscal package, conservatives in the House have worked to box in their fellow Republicans, demanding budget resolution terms that both limit the scope for adding new tax cuts beyond the 2017 law and require significant spending cuts, likely including substantial cuts to Medicaid. Whatever the other merits of these choices, they will tend to push inflation downward, and a more benign inflation environment would mean more room for the Fed to keep short-term rates lower — which should flow through as lower long-term rates right now. At least, that’s why Trump officials would like to think long-term rates are falling.

On the other hand, another reason that long-term interest rates might fall is that the outlook for economic growth is getting worse. Interest rates tend to fall in recessions as demand for capital fades. And there have been some worrying economic signals in the last few weeks, including pullbacks in consumer spending and manufacturing orders. Another increasingly worrying signal is coming from the stock market: the S&P 500 has fallen about 5% in the last two weeks and is now below its level when Trump was inaugurated. If long-term interest rates were falling because the outlook was shifting toward lower inflation and looser Fed policy over the coming years, you might expect stocks to be going up.¹ But if they’re falling because the investment demand outlook is weak, that’s more consistent with falling stock prices.

Still, it’s worth considering the possibility that several things are happening at once. It’s possible that the Trump administration, by sending forceful signs that it intends to engage in fiscal austerity, is bringing down interest rates, and that this — combined with deregulation — is encouraging investment and also pushing down long-term rates. At the same time, it’s also sending signs that the tariff threat is more real than market participants had expected before the inauguration. Even if tariffs have an ambiguous effect on inflation, their effect on business investment and the economic outlook is negative — and this is a factor pushing down both interest rates and stock prices.²

That is, long-term interest rates could be falling for good and bad reasons simultaneously. Then the big question for the US economy is which of these factors is more important: supply-side policies that de-congest the economy, or tariffs and any other damaging policies that discourage investment and growth? Bessent alluded to this balance in response to a question from Brennan about how much the tariffs will cost American consumers. He said, “it's a holistic approach, that there will be tariffs, there will be cuts in regulation, there will be cheaper energy.” In other words, Bessent can’t bring himself to claim the tariffs won’t impose costs on consumers, but he claims those costs will be offset by savings from other policies. This is roughly the pitch at the macroeconomic level, too: tariffs might cause some economic pain, but that pain will be mitigated by other policies that boost growth and investment.

My read of the current data is that the administration should be wary, but not panicked, about how the economic outlook has changed. There’s been a lot of attention to the GDPNow indicator from the Federal Reserve Bank of Atlanta, which is now pointing toward a significant GDP contraction for the first quarter (an annualized rate of nearly 3%) because of weak January data on consumer spending and manufacturing orders. I would encourage you not to focus too much on one or two data points, especially because picking and choosing tends to bias you toward negativity. Goldman Sachs points out some reasons to think the Atlanta number is an outlier — for example, the January figures were influenced by weather events and statistical issues related to seasonal adjustments that arise every January — and they have cut their growth forecast only modestly, to +1.6%.

And I also have a note of political caution for Democrats. One of the things we saw over the last four years was that, in tight economic conditions, economic policies that sound popular (checks! debt forgiveness!) can cause significant political pain when they cause inflation by overstimulating the economy. The reverse is also true: unpopular-sounding austerity policies (layoffs! Medicaid cuts!) may produce a surprising political dividend if they actually work by moderating inflation and allowing interest rates to fall. There are pitfalls awaiting Republicans — the more tax cuts they layer on, the less that austerity dividend will be; if the tariffs get large enough, they will swamp the benefits of other pro-growth policies; and specifically ill-targeted spending cuts may produce deteriorations in government service that are very unpopular in their own right.

That second pitfall — too-large tariffs — is one the administration looks increasingly determined to fall into. If Trump delivers on Bessent’s core insight — that austerity and deregulation means growth and lower interest rates without higher inflation — then he is likely to be rewarded by voters for his overall management of the economy. But Trump appears increasingly determined to impose tariffs that are far larger than those he imposed during his first administration, and likelier to raise politically sensitive consumer prices while materially harming growth. And if he does that, any intended austerity dividend is likely to go unnoticed by voters.

Very seriously,

Josh

1. This is especially true because, all else equal, lower interest rates should tend to push up all asset prices, including stock prices.

2. Indeed, the clear negative market reaction to tariffs could be seen again today, with an immediate drop in stock prices when President Trump told reporters he would not further delay 25% tariffs on Canada and Mexico.