NPR.
This is The Indicator from Planet Money.
I'm Paddy Hirsch.
And I'm Adrian Ma.
It's an exciting week for The Indicator because we find out tomorrow how much the Federal Reserve will cut interest rates.
And while it looks like there will be a cut, it's not clear just how deep that cut will be.
Now the smart money, the analysts and Wall Street types.
They're predicting maybe a quarter of a percentage point cut or maybe a half a percentage point.
Well, who knows?
But however deep the Fed goes, It probably won't be deep enough for President Trump.
On his social media platform, Truth Social, a couple of months ago, Trump wrote Fed should cut rates by three points.
Very low inflation.
One trillion dollars a year would be saved.
Were there any exclamation points there?
Oh, yes.
Three.
Three exclamation points for, I guess, a requested three percentage point reduction.
Or maybe if you want to be fancy about it, call it 300 basis points.
We're fancy.
And you know, a cut of that size would take the Fed funds rate from four and a half percent today to just one and a half percent.
That would be a massive cut.
Massive indeed.
So on today's show we'll look at what might happen if the president got his way and the Fed did indeed cut rates by three percentage points.
What would that do to inflation, to mortgage rates?
Would it save a trillion dollars a year, as Mr. Trump claims?
And explore it all after the break.
This message comes from NPR sponsor, Capella University.
With Capella's FlexPath learning format, you can set your own deadlines and learn on your schedule.
A different future is closer than you think with Capella University.
Learn more at capella.edu.
What's in your wallet?
Terms apply.
See CapitalOne.com slash bank for details.
Capital One N.A., member FDIC.
This message comes from NPR sponsor Sierra.
Ever found yourself waiting on hold, losing patience, and then hanging up?
It's frustrating and all too common.
That's why there's Sierra, the AI platform that makes talking to businesses easy.
No stock answers, no hold music, just real solutions fast.
Visit Sierra.ai to learn more.
The Federal Reserve traditionally is not an incautious animal.
It is not your 3,000-pound rhinoceros thundering across the savannah.
No, it's more like your 20,000-pound elephant tiptoeing through the trees.
I like the image of a tiptoeing elephant.
Yeah, they have this thing where they hollow out their feet.
They're really super stealthy when they want to be.
Okay so, the point being that the Fed can move fast and aggressively when it wants, but normally, with interest rate movements, they only make those in very small and incremental ways.
A quarter point here, maybe a half point there.
So very gingerly making these interest rate moves.
Gingerly.
Yeah.
So while President Trump leads the Republican Party and the party's symbol is indeed an elephant his call for a three percentage point cut to the base interest rate well, that's more rhino than dumbo.
He's focused on the rates that people pay for home mortgages.
Michael Strain is an economist at the American Enterprise Institute.
That's a think tank that leans to the right.
He's focused on the rates that businesses pay for longer term projects.
He's focused on car loans, you know, things of that nature.
Loans of that nature tend to be longer-term deals like a 30-year mortgage or a 7-year corporate loan or an 8-year car loan.
Trump wants to bring interest rates on these kinds of loans down.
But there's a problem.
I think the president is fundamentally confused about how those longer-term interest rates work.
Yeah, as all loyal indicator listeners know, the Fed effectively sets the base rate, the rate at which banks borrow from each other overnight.
Michael says that overnight rate has a big impact on short-term interest rates like a six-month bond or a one- or two-year bond.
But when you're talking about 30-year bonds, mortgage interest rates, when you're talking about rates on securities of that duration, those are really determined by market forces.
Market forces as in supply and demand.
Kamal Shree Kumar is president of Shree Kumar Global Strategies.
He advises institutions on investment risks in different countries around the world.
Shree says a deep rate cut would have a big effect on the demand side of the equation.
It is going to put an enormous amount of cash into consumer wallets.
Yeah, it would indeed make it way cheaper to borrow short-term.
But cheaper money means easier money, means more money, means That means inflation will go up, even as the federal funds rate, six-month Treasury bill and two-year Treasury yields all come down.
Inflation.
As we know, it makes money that's been borrowed worth a lot less when it's eventually paid back.
So lenders need to find ways to compensate for that erosion in value over the long term and also plan for the risk of even higher inflation down the road.
So how do they do this?
By charging higher rates on longer-term loans like car loans and corporate loans.
They all start getting more expensive.
And the more expensive the loans become, the fewer people that are qualified for them.
The same calculation goes for mortgage rates as well.
And that means that the mortgage rate goes up.
Given your level of income, your employment status, your debt history, you do not qualify for a mortgage at a higher rate.
So mortgages are hit, Demand for housing is hit, and then you end up with a much lower rate of growth than otherwise.
All right.
So a deep cut in interest rates would likely end up being bad for individuals and businesses.
Higher inflation and rising interest rates on consumer and corporate loans.
But what about the government?
Could a three-point cut save the government a trillion dollars a year, like Mr. Trump says?
Trump appears to be talking about the amount of interest we pay on U.S. government debt.
This year, it'll stack up to about $952 billion.
And the president's thinking that a big cut in the Fed funds rate will bring down the rate on longer-term government debt stuff like the 10-year Treasury note.
Yeah, but just like with consumer loans, the interest rates on long-term treasuries are driven primarily by the market, not by the Fed.
If the Fed does the president's bidding and slashes the base rate, the big funds that buy a lot of this treasury debt are likely to predict an increase in inflation and they'll react accordingly.
If today you have an interest rate of say, 43 on the 10-year period, They don't want to lend Uncle Sam for the next 10 years, for 43.
They think they'll be losers.
Treasury's debt servicing expenses actually shoot up once that happens.
In other words, a deep, steep rate cut by the Fed wouldn't do what Trump thinks it would.
Instead, it would probably do the opposite.
Inflation would almost certainly rise.
Long-term interest rates would probably increase.
Government borrowing costs would likely grow.
And Mike Strain with the American Enterprise Institute says if the cut came because the president ordered it.
That could do real long-term damage beyond the considerable fiscal and economic costs.
Investors would perceive holding US government debt to be riskier than they had previously perceived it to be.
They would see an erosion in the norms and institutions here in the United States.
If the Fed were to cut interest rates by 300 basis points, that would be a pretty big crack in the foundation of prosperity.
And that would make the whole house on which that foundation rests less stable and less secure.
Both Michael and Sri agree that Mr Trump's desire to bring long-term interest rates down is a good one.
High rates on consumer and corporate loans and mortgages are a threat to growth and to the biggest engines of the economy.
And high rates on government debt raise the government's operating costs and add to that debt load.
But they say using the Fed to drive these rates down is most definitely not the way to go.
Shree says at least some of Trump's people seem to understand that.
Scott Besant, having been a very successful hedge fund manager in his past, is bright enough, intelligent enough.
And he did say what we are planning to do is to cut the 10-year yield.
We are not trying to work on the federal funds rate, which is the only thing the Fed controls.
Well, the Treasury Secretary is on record saying he thinks the Fed funds rate should be a lot lower.
That is true, but he's not talking about a massive one-time cut.
He's talking about starting with a 50 basis point reduction, which is more tiptoeing elephant than charging rhino.
So he seems to get it.
Hopefully he can explain that to his boss.
This episode was produced by Corey Bridges with engineering by Robert Rodriguez.
It was fact-checked by Sierra Juarez, edited by Julia Ritchie, Kate Cannon is our editor and the indicators are production of NPR.
