At the start of Trump's second term, the White House economic team constructed a seemingly perfect macroeconomic logic: by increasing fiscal revenue and indirectly reducing the federal deficit, a sound fiscal signal would be sent to the bond market, forcing long-term interest rates to decline autonomously, thus achieving the ideal of stable economic growth and low interest rates without the need for further easing from the Federal Reserve. However, within just a few months, this core bet completely failed. With persistently rising inflation, the Federal Reserve resuming interest rate hikes, and long-term Treasury yields soaring to their highest levels since 2007, the Trump administration's original economic governance vision was thoroughly thwarted by its own policy mix, geopolitical conflicts, and the AI industry boom.

Policy Creates Inflation: Six Measures Combined, Completely Deviating from the Vision of Deflation

This round of inflationary rebound and the high-interest-rate dilemma is essentially a consequence of the combined effects of multiple policies implemented by the Trump administration. The White House had previously underestimated the inflationary pressure exerted by its own measures. Imposing tariffs on imports directly raised the cost of goods; the Iran war triggered a global energy crisis; strict immigration policies compressed the domestic labor supply; and these, coupled with tax cuts, increased fiscal spending, and continued pressure on the Federal Reserve to cut interest rates, created a clear upward pressure on inflation, contrary to the government's anticipated deflationary path.

Geopolitical conflicts have become the biggest short-term inflation disruptor.

The Trump administration had previously predicted that the conflict with Iran would only last two or three weeks and that energy prices would fall rapidly, failing to prepare for a long-term inflationary shock. However, the situation continued to spiral out of control, with crude oil and diesel prices remaining high. Diesel, as a core component of the industrial economy, runs through the entire chain of agricultural production, logistics, and commodity circulation, thus transmitting the pressure of rising energy prices to the real economy in all aspects, gradually turning the short-term energy shock into a persistent inflationary threat.

Economic resilience has actually exacerbated inflation entrenching.

With the current US unemployment rate hovering around 4%, robust consumer demand and steady economic growth, strong end-user demand gives businesses ample capacity to pass on costs, allowing them to smoothly transmit the pressure of rising energy and raw material prices to consumers. At the same time, workers are continuously pushing for wage increases to hedge against rising prices, further creating a "cost-wage" spiral that makes it difficult for inflation to cool down quickly, and also provides fundamental support for the Federal Reserve to continue raising interest rates.

Fiscal commitments have completely failed: soaring deficits and the shortcut of interest rate cuts have become utterly ineffective.

During the campaign, Treasury Secretary Bessant unveiled the core economic agenda, the "3-3-3" plan, promising to reduce the fiscal deficit to 3% of GDP, boost real economic growth to 3%, and add 3 million barrels of energy equivalent per day. The plan aimed to stabilize the bond market and lower interest rates through fiscal repair. However, to date, this agenda has almost entirely failed to materialize. Many deficit-reduction measures attempted by the White House have yielded minimal results. The government efficiency reform department led by Musk, which initially promised to cut $2 trillion in fiscal waste, ultimately achieved almost no substantial results. The path of generating revenue through tariffs was also disrupted by a Supreme Court ruling, forcing the termination of several tariff policies due to a lack of legal authority. Subsequently, the government turned to "trading revenue for growth," attempting to reduce the deficit through economic expansion. However, while the US economy is expected to maintain steady growth in 2026, the fiscal deficit will remain at nearly 6% of GDP, matching the historical high during the Biden era, and the fiscal imbalance problem remains unresolved. Even more contradictory is that the Trump administration, while claiming to reform the fiscal system, continues to release expectations of further easing. On the eve of the midterm elections, Trump promised a $5,000 cash subsidy to all citizens, contingent on the Republicans retaining seats in both the House and Senate. This exposed a lack of sincerity in fiscal austerity and fueled market concerns about the long-term fiscal sustainability of the United States. Uncontrolled fiscal policy has directly triggered a chain of risks. This fiscal year, interest payments on US federal debt have exceeded $1 trillion, surpassing military spending for the first time. The heavy debt burden has squeezed the scope for fiscal policy adjustments, leaving the government without sufficient hedging tools should the economy subsequently fall into recession. Meanwhile, mortgage rates surged from 6% in February to over 7%, increasing annual mortgage payments on a $400,000 mortgage by approximately $3,000, significantly increasing debt burdens for residents. Wage growth has consistently lagged behind inflation since March, leading to a continued decline in purchasing power.

The AI boom has become a new variable: capital inflows are driving up interest rates, completely disrupting traditional regulatory logic.

Beyond policy and geopolitical risks, the unexpected boom in the AI industry, unforeseen by the White House, has become a core driver of rising long-term interest rates and a unique characteristic of the current macroeconomic landscape. The massive investment boom in AI computing infrastructure, chip equipment, and power supply has not only driven up costs in the physical supply chain but also created fierce competition for borrowing funds between the US federal government and the capital market. Traditional macroeconomic logic dictates that high interest rates suppress corporate investment and cool the economy, but the AI oligopoly has completely defied this pattern. Leading tech companies' AI ecosystem development and computing power arms race offer virtually unlimited long-term returns, making them completely insensitive to minor interest rate hikes. Even with continued Fed rate hikes and high funding costs, they maintain high-intensity capital expenditures and multi-billion dollar stock buyback programs. The latest August equipment financing data also confirms this: although capital expenditures have slightly declined from the July historical peak, they remain at the second-highest level in history, with total equipment investment in 2026 projected to reach a record high, demonstrating the continued resilience of AI-driven investment. This structural capital drain, coupled with persistently high US fiscal debt issuance needs, has collectively fueled inflated long-term interest rates. The market no longer prices interest rates solely based on inflation data, but simultaneously considers the risks of fiscal deficits and the rigid funding needs of the AI industry, ultimately driving the yields on 10-year and 30-year US Treasury bonds to new highs since 2007.

Federal Reserve policy shift: Change of leadership unlikely to alter the overall trend, interest rate hikes are inevitable.

Trump had hoped to lower debt servicing costs and boost the economy through looser interest rates by replacing the Federal Reserve chairman, but this plan completely failed. In 2025, the Fed cut rates three times due to expectations of a weak labor market, but with the ongoing conflict with Iran, entrenched energy inflation, and AI-driven economic resilience exceeding expectations, the pace of inflation decline was significantly slower than market expectations. After taking office, new Fed Chairman Warsh completely reversed the easing expectations, restarting rate hikes in September 2026, ending a three-year rate-cutting cycle. The core logic behind the Fed's change in attitude is clear: the market had previously overestimated that the energy shock would subside quickly, but persistently high oil prices and widespread cost transmission have transformed inflation from a short-term disturbance into a medium- to long-term threat, forcing the central bank to restart tightening policies to anchor prices. This rate hike has also triggered policy disagreements between the White House and the Fed, and has caused a division within the Trump camp. White House Economic Council Chairman Hassett publicly questioned the interest rate hike decision, arguing that core inflation has improved significantly and that continued rate hikes are irrational. Some former Treasury officials bluntly stated that rate hikes cannot cure current inflation, citing high oil prices and the interest rate desensitization of the AI industry as rendering traditional monetary policy ineffective. Some advisors also believe that Warsh needs to establish credibility in combating inflation and solidify the Fed's policy authority through rate hikes.

Accumulated Tail Risks: The Hidden Risk of Recession Beneath the Illusion of Economic Resilience

The current robust performance of the US economy has actually amplified long-term risks, sowing the seeds for a subsequent crisis. On the one hand, persistently high long-term interest rates not only suppress household consumption and business investment but also continuously increase the federal government's debt burden, creating a negative cycle of "high interest rates → high debt servicing costs → high deficits → even higher interest rate premiums." On the other hand, the US fiscal system has no room for maneuver; the current deficit ratio is already close to 6%. If the economy subsequently falls into recession, tax revenue will decline, and spending on people's livelihoods will passively increase, likely causing the deficit ratio to soar to 8%-9%. Historically, long-term bond yields have typically fallen sharply during recessions, but under the pressure of massive debt issuance in this round, the market may refuse to absorb the massive amount of US Treasury bonds, significantly compressing the room for interest rate declines and creating a rare predicament of "recession + high interest rates + high deficits." More importantly, neither party in the US has the resolve to reform, and core deficit sources such as Social Security and Medicare have remained unaddressed for a long time, completely dashing market expectations that high interest rates would force fiscal reform. In the short term, the situation in the Middle East, the midterm elections, and fluctuations in the AI industry continue to disrupt the market; in the medium to long term, the Trump administration's economic bets have completely failed, establishing a stable pattern of high inflation, high interest rates, and high deficits, and laying the groundwork for future economic fluctuations and asset repricing in the United States.

Key takeaways:

The Trump administration initially attempted to leverage fiscal repair to lower interest rates and achieve stable economic growth. However, its own tariff, immigration, and fiscal expansion policies, coupled with the dual exogenous variables of the Iranian geopolitical conflict and the massive capital drain from AI, completely overturned its original macroeconomic vision. Solidified inflation, high interest rates, and out-of-control deficits have become the core characteristics of the current US economy. The diminished effectiveness of traditional monetary policy tools, the deadlock in fiscal reform, and the continued structural competition for capital mean that this round of high interest rates and high inflation is unlikely to reverse quickly, and the US economy and capital markets will pay the price for this failed economic bet in the long term.