Photo by Jungwoo Hong
Back in February, before Trump and Netanyahu attacked Iran, the interest rate on 10-year Treasury bonds was around 4.0%. It’s now hovering near 4.7%, an increase of 0.7 percentage points or 70 basis points. That’s a big deal for the economy.
Most immediately, it will be harder for people to buy a home, as mortgage interest rates have risen by roughly the same amount. For someone looking to borrow $300,000 to buy a house, Trump’s war has cost them an extra $2,100 a year in mortgage payments.
It will also make it more expensive for state and local governments to pay for infrastructure or borrow for other needs. And corporate borrowers will have to pay more, notably the hyperscalers who are spending massive sums for building out their network of data centers. If they are carrying another $1 trillion in debt after a couple of years, a jump of 70 basis points will add $7 billion a year to their interest payments, in addition to the impact of any increase in the risk premiums they may face.
It’s worth noting that none of this increase in interest rates is due to an expectation of higher inflation. If anything, the rate of inflation expected now is slightly lower than it was when Trump started the war.
The rise in interest rates means that investors are expecting higher real interest rates now than they did six months ago. There are two stories as to why we might have expectations of higher real interest rates now.
The first is simply that there will be greater demand for borrowing. Part of this could be expectations on data centers are now higher than they were six months ago. That could be true to some extent, but investors were already anticipating massive spending on AI six months ago. It’s hard to imagine that expectations have increased that much.
The other reason expectations might have changed is that investors now anticipate considerably larger budget deficits than they did six months ago. Trump is requesting a $1.5 trillion military budget for fiscal 2027, which starts in October. That is up from $860 billion in the last Biden budget. This is an increase of more than $600 billion, which is nearly 2% of GDP, enough to have paid for extending the Biden ACA subsidies for twenty years. In other words, it’s real money.
I don’t find the demand for borrowing explanation entirely plausible, since the interest rate is not set directly by the supply and demand for savings. It’s set by the supply of money. And here there is a story that fits. The Federal Reserve Board is now projecting that the Federal Funds rate will be 0.5 percentage points higher in 2027 than they had before the war and 0.3 percentage points higher in 2028 than they did before the war. Assuming that the Fed’s open market committee members reflect attitudes of investors more generally, this could easily explain the jump in interest rates since the start of the war.
One item that is worth noting in this respect is that long-term interest rates on other countries’ debt have risen by a similar amount. While most have long-term rates that are lower than in the U.S., for example, Germany’s 10-year rate is 3.2%, and France’s is 4.1%, the increase has kept the gap roughly constant. This means that Trump’s war has raised interest rates for the whole world. Yet another reason for them to be thrilled with the United States under Donald Trump.
This first appeared on Dean Baker’s Beat the Press blog.
