Last week, the US Federal Reserve made the decision to raise the federal funds rate, for the first time in three years, by a quarter of a percentage point to a range of 3.75 per cent to 4 per cent.
This was sensible, indeed overdue, given its consistent failure to hit the inflation target. US president Donald Trump responded with predictable fury, stating that “Interest Rates in the United States should be 1%, or less, because we are the Best Credit in the World — BY FAR”, though he did also stress that “I told Kevin, I said, you might as well vote with the board because it’s just not going to matter. The board is very hostile,” adding that it “is raising . . . only for political reasons, and that’s a raise against Trump.”
This, not surprisingly, is altogether ridiculous.
It is too soon to be confident. But what Fed chair Kevin Warsh has been saying and doing is comforting. Moreover, Trump is even helpful. If his alternative made any sense, it might carry some weight. But it does not. The Fed must either ignore him or throw in the towel in the fight to meet its mandate. Warsh, it seems, is aware of that. Still better, the Fed’s decision to raise was unanimous.
Warsh made two important points in last Wednesday’s press conference. One was that “for more than five years, inflation has been running above target. So, our predominant focus is on the price-stability side of our mandate.
The plain fact is that inflation is too high and has been for too long.” The other was that “our decision comes at a time when the American economy appears to be strengthening . . . So we removed a dose of accommodation.”
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In other words, this was a needed, yet modest, tightening. On one point, this view is unchallengeable: not just headline inflation but other measures have remained persistently above target since 2021. Such overshooting makes the target a mockery.
Moreover, given the investment triggered by artificial intelligence (AI), Trump’s loose fiscal policy, his tariffs and his decision to create a substantial energy shock with his war on Iran, there was little reason to expect inflation to go back to the target. The opposite was more likely.
This is not to say that all doubts about the Warsh Fed should be put to one side. Claudia Sahm, one of its most influential observers, asks some penetrating questions in her Substack. How, in Warsh’s view, does monetary policy contribute to growth?
How does a tighter monetary policy lower inflation, other than by slowing the economy? Does he have any idea of what the “neutral rate” is? If not, how does he judge how “accommodative” policy now is? Warsh could and should answer these questions without abandoning his scepticism about the “forecastability” of the economy, on which I share his doubts.
Far more important is that he has refused to offer any intellectual or rhetorical support to Trump’s demand for a huge cut in interest rates. The Fed is taking a conventional view of its twin objectives of low inflation and high employment.
Meanwhile, Trump’s assertion that the rate should be 1 per cent because the US is “the Best Credit in the World” is irrelevant and absurd.
It is irrelevant, because the short-term policy rate depends on macroeconomic conditions, notably current and expected inflation and unemployment.
In a country with a creditworthy state, longer-term nominal rates are determined by real rates of interest, expected inflation and various perceived risks. The first is determined by expected macroeconomic conditions over the long run.
If we subtract the yield on 10-year Treasury Inflation-Protected Securities (Tips) from conventional 10-year bonds, we get the market’s compensation for inflation over the period. This will be related to expected inflation, but not identical to it, because of the need to protect against risk.
On September 17th, the yield on 10-year Tips was around 2.6 per cent, the conventional bond 4.9 per cent and so inflation compensation 2.3 per cent. Both nominal and real yields are roughly where they were before the financial crisis of 2007-09. Inflation compensation is, if anything, also modest, given the shocks since 2021.
In sum, nominal yields seem to be at reasonable levels, given today’s robust recent economic performance.
Indeed, one might wonder whether these yields should even be higher, in view of the possibility that the US government might, at some point, find it hard to fund itself on favourable terms.
Given its huge fiscal deficits, the need for foreign funding of a country running a huge current account deficit and the shift from long-term holders of its bonds to financing by hedge funds, a funding crisis is at least imaginable. In that situation, some combination of Fed emergency funding with financial repression seems likely.
Moreover, Trump’s statement that the US is the “best credit” in the world is untrue. It has the biggest and arguably strongest economy. But the root of the word “credit” is the Latin word “credere”, which means “to believe”.
It is remarkable that investors continue to trust the public debt of a country able to elect a man as radically untrustworthy as Trump – twice. Given that his policies, notably his fiscal ones, are so reckless, and those elsewhere, notably on tariffs, so rule-breaking, confidence in the US government is remarkable. But if his demand for policy rates at 1 per cent (minus 2 per cent real) were delivered, it would surely trigger a lenders’ strike.
The Fed’s job is to keep inflation under control, regardless of political pressure and absurd arguments from a desperate president. Meanwhile, we see a battle not just between the Fed and Trump, but between a fundamentally strong economy and an irresponsible government. How that ends is one of the most important issues of our era. - Copyright The Financial Times Limited 2026
