President Donald Trump Is Playing a Game of Chicken With the Federal Reserve. Who Will Blink First?

President Donald Trump has not been shy about his desire for the Federal Reserve to lower interest rates. Lower rates have historically been good for stocks; they make the cost of borrowing cheaper, which would help the country's future debt issuances, and they would also lower mortgage rates, assisting a broad swath of Americans who have been priced out of the housing market.

Trump's request for lower rates, however, has been more or less denied by Federal Reserve Chair Jerome Powell, who thinks the Fed needs to take a wait-and-see approach, given recent data, and to see how recent policy initiatives by Trump will play out. With recent tariffs, Trump seems to be playing a game of chicken with the Fed. Who will blink first?

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Can Trump push the Fed to lower interest rates?

Since the campaign trail, Trump has made it abundantly clear that he planned to impose tariffs to address the country's global trade deficit and bring manufacturing and higher-paying jobs back to the U.S. Many investors believed Trump would take a more scaled-back approach, assuming the president cares too much about the stock market to implement anything too drastic. However, this view, known as the "Trump put," has turned out to be untrue so far.

Meanwhile, Trump has announced much more severe tariffs than anyone could have anticipated, and driven down U.S. Treasury yields significantly since taking office. Granted, President Trump on Wednesday afternoon did announce a 90-day pause on some tariffs he previously assessed or a lowering to 10%. But he also announced more severe tariffs on China. Trump's lack of consistency on tariffs provides some justification for Powell's wait-and-see attitude.

Data by YCharts

Treasury yields are driven by several factors including economic growth expectations, inflation expectations, and interest rate expectations. They have been on the decline as economists have begun to lower their projections for U.S. gross domestic product (GDP), spurred by slowing economic data and Trump's tariffs, which many believe will have a sobering effect on growth.

The tariffs have led many analysts and economists from major banks to boost their odds that the U.S. economy tips into a recession this year. This, in turn, has led options traders to bet on four rate cuts from the Fed this year. Traders are pricing in a nearly 63% chance of a cut at the Fed's June meeting (as of April 8). Remember, these percentages can change frequently.

So, one might think that Trump's plan is working. However, Powell at least attempted to pour cold water on this idea, saying on April 5, "It feels like we don't need to be in a hurry," in regard to interest rate cuts. He continued, "We're going to have to wait and see how this plays out before we start to make adjustments." Powell expressed some concern that the steep tariffs could lead to more "persistent" inflation than initially believed.

Recent data hasn't necessarily suggested that inflation has been stomped out, either. The U.S. added more jobs than expected in March and inflation remains above the Fed's preferred 2% target. Interestingly, the 10-year yield has also bounced, as of this writing.

Who will blink first?

It's hard to know the exact near-term impact of Trump's tariffs and Trump may also end up striking trade deals with other countries at some point. Powell initially said that the Fed's base case for the tariffs was for them to lead to "transitory" inflation, although at the time Powell and his team likely had no idea that the Trump administration would impose such sweeping tariffs.

I don't think Powell will be inclined to meet Trump's demand unless the data shows that cuts are warranted. However, Powell won't be afraid to act either. After all, the Fed cut rates by 75 basis points last year including a jumbo 50-basis-point cut. The 10-year yield is certainly one indicator to watch. If you're Trump, you definitely don't want it to drift higher because that ties the Fed's hands and could hint at rising inflation. Powell and the Fed won't want to cut if the economy continues to look like it's on good footing or still running too hot because it still hasn't seen the impact of tariffs on inflation, and cutting rates could risk reigniting inflation.

The only way Powell will blink is if data shows a clear recession. But even then, the tariffs have actually added another layer of uncertainty because many believe they will have some inflationary effect, which could take time to play out.

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