US president Donald Trump’s determination to force interest rates to 1% would upset the US market and investors, according to experts.
Trump wants lower interest rates to try and offset the expected economic slowdown caused by increasing consumer costs and stalling global trade, thanks to his wide-sweeping tariffs.
Last week, the president once again called on Fed chair Jerome Powell to lower rates, with Powell standing firm at 4.25% to 4.5%, citing ongoing economic uncertainty and the fact inflation remains above the Fed’s 2% target.
Ultimately, it’s a careful balancing act – cut rates too early and inflation soars, while going too late could bring the economy to a screeching halt. What we are witnessing is a power struggle between Powell and Trump to see who gets to tip the balance.
Guy Stear, head of developed markets strategy at the Amundi Investment Institute, said: “Fiscal policy is already expansionary. Cutting rates to 1% would be like bringing out a second punch bowl and not taking the current one away.”
There is concern that a 1% interest rate environment would increase the risk of reigniting asset bubbles.
Tina Fong, economist at Schroders, said: “Historically, low interest rates have tended to create a very supportive environment for risk assets, but the extent of this risk depends on factors such as monetary and liquidity conditions, as well as broader structural dynamics.”
For instance, if 1% interest rates are not matched by higher inflation, real rates could remain restrictive, limiting the upside for risk assets such as equities, she said.
However, Stefano Amato, multi-asset fund manager at M&G Investments, argued that it could further “boost” risk appetite for US equities and potentially fuel outperformance in more speculative areas, like meme stocks, or hard assets such as gold and bitcoin.
He said investors may “seek alternatives to flat currencies in a low-rate, high-uncertainty environment”.
If US interest rates fell to 1%, borrowing costs would decline which would potentially encourage governments to increase spending, added Fong.
“While this could support growth in the short term, it may also exacerbate debt sustainability concerns,” she said. “In turn, the rising risk of a global fiscal crisis could push bond yields higher as investors demand greater compensation for sovereign risk.”
This concern was shared by Max McKechnie, global market strategist at JP Morgan Asset Management, who agreed that politically motivated interest rate decisions would likely increase the term premium investors require to hold longer-term US debt.
“Any boost from falling interest rates would ultimately be counteracted by rising bond yields,” McKechnie said.
Due to the growing divergence at the long end of the curve, some strategic bond managers have gone short on US treasuries instead.
Consumer mortgages, corporate borrowing costs and equity valuations are also closely linked to longer-term bond yields, so the net impact of aggressively cutting interest rates would therefore “not be as beneficial as the US administration may hope”, added McKechnie.
The Treasury has limited tools to correct this, experts said, warning that pressure could shift to the US dollar – raising questions about its long-term credibility as a reserve currency.
“If the yield curve steepens enough, currency-hedged treasury positions could look very attractive to investors outside the US,” said Amundi’s Stear.
“It seems likely, however, that few investors would want to buy the US without a currency hedge under this scenario.”
More broadly, evidence of sustained political pressure on the Fed could cause international investors to reconsider the safe-haven status of US assets, experts agreed.
US inflation has been coming down gradually. It has halved since June 2022 highs of 9%, notably without raising the unemployment rate.
The latest decision to hold interest rates was opposed by Republican Fed governors Christopher Waller and Michelle Bowman, marking the first time two governors have dissented since the early 90s.
The next decision on rate cuts is set to take place in September.
Fong said that, for the Fed to lower rates to 1%, the US would “likely need to enter a recession”.
“The S&P 500 has typically sold off at the onset of recessions, particularly during the first three months, with defensive sectors such as consumer staples and healthcare typically outperforming.”