The Federal Reserve continues to keep interest rates steady

Inflation, Treasury Debt, and the Job Market: Why the Fed isn’t Doing What It Means to Do?

This shouldn’t come as a surprise. President Trump’s proposed policies are expected to add to inflation. And to the degree they are enacted, they will combine with an inflation rate that has declined rapidly, but which remains above the Federal Reserve’s target and is still higher than it was during most of the decade leading up to the pandemic. Since long-term interest rates are directly linked to 10 year Treasury yields, rising rates are bad for businesses and households that need to borrow.

Fed policymakers don’t want to make further rate cuts if the job market isn’t good and prices are rising.

Concern that the new administration will increase the budget deficit is also a factor. Even before any new stimulus this year, the Congressional Budget Office has estimated the budget deficit will widen from $1.9 trillion in 2025 to $2.7 trillion by 2035.

The Treasury will need to increase the amount of bonds it issues to fund bigger deficits. The need to find willing Treasury buyers increases due to the Fed selling its own stock of bonds left over from the financial crisis. Many potential overseas buyers are set to face increased tariffs from the United States and may prefer investment options outside America. Economics 101 tells us that there is more supply than there is demand. In the case of bonds, lower prices mean higher yields. Investors are saying, essentially, they want to be paid more to hold America’s debt.

“I have seen nothing in the data or forecasts that suggests the labor market will dramatically weaken over coming months,” Fed governor Chris Waller said this month.

Meanwhile, the job market has proven to be remarkably resilient, with employers adding more than a quarter-million jobs last month. If the labor market were weaker, there would be more pressure on the Fed to cut borrowing costs and stimulate hiring.

The central bank has already cut its benchmark rate by a full percentage point since September. But faced with sticky inflation, policymakers are in no hurry to make additional cuts. Consumer prices in December were up 2.9% from a year ago — a slightly larger annual increase than the previous month.

It was widely expected that the rate would be left unchanged, but it will set off a potential clash with President Trump, who told reporters earlier this month that interest rates are too high.

The central bank left its benchmark interest rate at between 4% and 4.5%. That helps determine how much other short-term borrowing costs will be.

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“We have to see what policies are enacted before we can seriously consider their effects”, he added in the speech. “But my bottom-line message is that I believe more cuts will be appropriate.”

There was considerable disagreement within the rate-setting committee, however, with one member projecting no rate cuts in 2025 and others predicting as many as four or five quarter-point reductions.