MILWAUKEE (DTN) -- The incoming Trump administration's tax policies will have a significant influence on how interest rates move over the next few years. Trump may also disrupt the Federal Reserve by attempting to aggressively influence the Fed's decisions.
Yung-Yu Ma, chief investment officer with BMO wealth management, spoke Thursday about the outlook for interest rates at the American Bankers Association's Agricultural Bankers Conference in Milwaukee. Ma focused on how some of the changes in federal policies under the Trump administration could affect interest rates in the future.
While the Federal Reserve maintains, the central bank is pushing to lower inflation to 2% annually, Ma said that's going to be hard to achieve. Inflation hasn't fallen that low and it doesn't appear likely.
"Once you are in normal growth mode, we don't think you can keep the current economy at an inflation rate around 2%."
Overall, Ma said research at BMO doesn't forecast any dramatic drops in interest rates longer-term. "We do think interest rates are probably where they are now. The long-term rates, they're not going to go much lower," Ma said.
FED'S POWELL SUGGESTS SLOW APPROACH
Fed Chairman Jerome Powell, in a speech Thursday in Dallas, indicated the Fed would not aggressively push more cuts without some dramatic changes in the economy. Powell said the Fed would move to a more "neutral" policy after cutting interest rates a quarter-point last week. "The economy is not sending any signals that we need to be in a hurry to lower rates," Powell said in his remarks. "The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully. Ultimately, the path of the policy rate will depend on how the incoming data and the economic outlook evolve."
TRUMP AGENDA: TAX CUTS AHEAD
Ma highlighted potential tax cuts, saying "one thing we are sure of" is that President-elect Donald Trump's 2017 tax cuts will be extended. Trump also has talked about lowering the corporate tax rate from 21% to 15% for domestic manufacturers.
But Trump also made promises to cut or eliminate taxes on tips, overtime pay and Social Security income. "Those are big ticket items," Ma said, adding, "Those are budget-busting types of items."
While Trump talked during the campaign about raising tariffs to generate more revenue, Ma said tariffs can't make up for lower tax revenues.
"You aren't getting a $2 trillion deficit dealt with what we have today," he said. "You aren't funding the government out of that."
DEFICIT PRESSURES
Trump, though, will be limited due to the current annual budget deficit and no specific plan to cut spending to offset those tax cuts. The federal government already spends 38% more than it collects in revenue. Interest payments on the debt now are greater than annual Defense spending.
"We think there will be some constraints on what the Trump administration is able to do with tax cuts," he said.
Ma said he thought it was less likely Trump would try to replace Powell until his term is up, but it's possible.
"If the interest rate policy goes strongly against what President Trump wants, he will start thinking about appointing a new chair," Ma said.
DEBT RISKS
The big risk with the country's overall national debt and budget deficits is that it creates a risk the federal government won't be able to address major economic downturns or disasters. Right now, however, it's unclear just when the country reaches that tipping point.
"What we are doing now really diminishes our ability to respond to the next crisis," Ma said.
Ma noted politicians right now are content to delay hard decisions on the deficits and the national debt. Austerity is not an election selling point, he said.
"The incentive for politicians is to kick the can down the road -- until there is a crisis that derails everything."
TRUMP AND THE FED
During Trump's first term he often expressed frustration at Federal Reserve moves and maintained the president should have more influence. In a question-and-answer Thursday, Powell said the public has more confidence in the Fed's moves because of its political independence.
If Trump were able to take more control over Fed decisions, Ma said there would be some loss of faith in the ability to steer the economy, at least temporarily. Then it would come down to who gets appointed and the decisions the Fed then makes.
"It's not a small question mark. It's a big question mark," Ma said. "The markets are going to react negatively first and then wait to see proof that things are actually OK. That would be my expectation. I don't think it's going to happen, but we don't know how things are going to play out."
TREASURY NOTES SENDING SIGNALS
While the Fed has been cutting short-term interest rates, Ma pointed out the 10-year Treasury notes are showing rising yields. The 10-year bond had a long-term decline in value for roughly three decades until 2021, and it started to rise. The bond has moved from 3.6% interest to 4.4% since the Fed started cutting rates again.
While some analysts forecast the 10-year Treasury going down, BMO sees "fair value" for 10-year rates 4.25%-4.75%, Ma said.
For now, investors expect some of Trump's policies will add to inflation and the national debt, which is pushing investors to seek higher rates on government bonds.
If the rates on the 10-year Treasury bonds continue to rise, however, going over 5% or hitting 6%, that type of increase "could cause pain" to the overall economy, Ma said.
"I think that would create enough pain that the president would actually shift his policies," Ma said.
OTHER INFLUENCES
Trump was elected in part by voters concerned about higher inflation and higher interest rates. Trump's push to aggressively deport people could lead to greater inflation if jobs remain unfilled in different sectors of the economy.
While Trump has vowed to unleash more oil production, Ma said it's unclear whether oil companies will want to produce more oil. The companies right now have an incentive to keep prices a little higher. "They don't want to flood the market, right, because that tends to depress profits," Ma said.
Also see, "Ag Bankers Survey: Profitability Concerns Rise Among US Farmers," https://www.dtnpf.com/…
"Financial Strain for Midwest Farms Could Demand Heightened Scrutiny From Bankers," https://www.dtnpf.com/…
"AFBF Pushes for Economic Aid to Support Farmers as Farm Bill Stalls," https://www.dtnpf.com/…
Chris Clayton can be reached at Chris.Clayton@dtn.com
Follow him on social platform X @ChrisClaytonDTN
(c) Copyright 2024 DTN, LLC. All rights reserved.