Following Joe Biden's disastrous performance in last week's presidential debate, the likelihood of a Donald Trump victory appears to have increased markedly.
If Trump wins, an important question for the economy and its finances is: what will happen to interest rates?
Rates during the Trump presidency (2017-2021) fell amid low inflation and moderate economic growth. They remained historically low during the first year of the Biden administration.
But rates began to rise in March 2022, when the Federal Reserve raised rates in the face of runaway inflation. That price increase was due to supply chain disruption and resulting shortages, heavy government spending to counter the impact of COVID, and copious money printing by the Fed to do the same.
Since the central bank stopped raising rates in July 2023, they have fluctuated and ultimately risen. The 10-year Treasury note yielded 4.48% on Monday.
Falling inflation and economic growth
Now, inflation and economic growth are moderating, so the question for investors is when the Fed will start cutting rates. The economy expanded a modest 1.4% annualized in the first quarter.
The central bank's preferred gauge of inflation, the personal consumption expenditures index, rose 2.6% in the 12 months through May, up from 2.7% in April. The Fed's inflation target is 2%.
The Fed is closely watching the core PCE index, which excludes food and energy. That gauge rose 2.6% over the past 12 months, the smallest gain since March 2021, and was down from 2.8% in April.
Related: Former Treasury official reveals surprising interest rate prediction
All of this data leads experts to expect the Fed to start cutting rates this year. Interest rate futures indicate a 63% chance that the Fed will cut rates at least once before September and a 61% chance that it will cut them at least twice before the end of the year.
The effects of rate fluctuations on you, the consumer, are varied. Higher rates mean higher payments on your bank accounts, certificates of deposit, and money market funds.
But you also pay more for your home, your car, your credit cards, your personal loans and your student loans. Lower rates mean the opposite for all of those areas.
Morgan Stanley and the Trump effect
So what does Trump mean for interest rates? Morgan Stanley strategists say it would likely mean lower short-term rates and higher long-term rates. That's known as a steeper yield curve.
“The sharp shift in odds in favor of President Trump may be a unique catalyst that makes curve steepeners attractive,” they wrote in a commentary. quoted by BloombergThey were referring to operations that would benefit from a steeper yield curve.
Related: Wall Street analyst reveals surprising prediction about the economy
An example would be buying short-term bonds and selling long-term bonds.
Slowing economic growth under Trump would push short-term rates lower as investors would expect the Fed to cut them to combat the slowdown, and long-term rates higher amid rising inflation.
Potential impact of deportations and higher tariffs
Trump's promise to keep new immigrants out and expel many of those already here could put a dent in the economy, Morgan Stanley analysts said. That's because his presence has helped employers find the workers they need, giving the economy a boost.
His promise to raise tariffs could also hurt the economy by making it more expensive for manufacturers to produce their goods.
Higher tariffs are also inflationary, as they push up the prices of goods subject to tariffs, which would tend to push long-term rates up.
More economic analysis:
- Record stock rally may be stalling
- Consumers are giving in to persistent inflation and a slowing job market
- Fed rate cut schedule shifts after retail sales data
Higher deficit spending could also lead to higher long-term rates, the strategists said. A higher deficit means the government issues more long-term bonds to fund it, and that puts upward pressure on long-term rates.
So interest rates could suddenly spike if Trump wins.
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