At the start of Trump's second term, White House economic advisers envisioned that if the bond market could be convinced Washington was serious about slashing the massive deficit, long-term interest rates would fall on their own and Trump would not need to interfere with the Federal Reserve.

Reality went the other way. Inflation has picked up again, the Fed has begun raising rates, and the 10-year U.S. Treasury yield is far above the level when Trump took office.

Last week, the 10-year Treasury yield touched its highest level since 2007. Investors now face a resilient economy, persistent energy supply disruptions, and a Federal Reserve that has run out of patience with inflation.

The White House's earlier fiscal consolidation vision has not materialized. Meanwhile, several of the Trump administration's own policies are adding to price pressures, including higher tariffs, immigration restrictions, and the war with Iran that has driven up oil and diesel prices.

Jessica Riedl, a former Republican Senate aide and now a budget and tax fellow at the Brookings Institution, said these policies, combined with tax cuts, new spending, and demands for the Fed to cut rates, mean "all six of these policies push inflation higher, not lower."

Rising long-term rates are increasing borrowing costs for households, businesses, and the government

Mortgage rates briefly fell to 6% in February but now exceed 7%. For a new $400,000 loan, that means roughly $3,000 more in annual interest payments.

At the same time, workers' wage gains have failed to keep pace with inflation since March. In the fiscal year through this week, the U.S. government has paid more than $1 trillion in interest on its debt, more than its military spending.

Nick Timiraos, chief economics correspondent for The Wall Street Journal and known as the "Fed whisperer," wrote that if the economy then stalls, the government will have even less fiscal room to respond to a recession. And as long as inflation cannot be sustainably cooled, the Fed may need to further slow economic and employment growth.

The U.S. economy remains resilient for now. Unemployment is near 4%, consumers continue to spend, and the economy keeps growing, but strong demand itself adds to inflation pressure.

When demand is strong, businesses find it easier to pass higher fuel costs on to consumers, and when the labor market is resilient, workers are better positioned to demand raises. Energy price shocks therefore spread more easily to other goods and services.

The deficit has not fallen as planned

The Trump administration initially tried to lower long-term rates by starting with fiscal consolidation. Treasury Secretary Bessent had made deficit reduction a core plank during the 2024 campaign.

He proposed a "3-3-3" agenda: cutting the deficit to 3% of GDP, raising inflation-adjusted economic growth to 3%, and increasing domestic energy production by the equivalent of 3 million barrels of oil per day.

After Trump took office, the Department of Government Efficiency was the first to be given high hopes. Elon Musk said the department could save $2 trillion by cutting wasteful spending, but actual results were limited. The administration then viewed tariffs as another path to reducing the deficit.

Tariff revenue hit records at one point, but the Supreme Court ruled this year that Trump lacked the authority to impose many of those tariffs, limiting that approach.

Now, another White House argument is to rely on economic growth to boost government revenue. "We can grow our way out of this," Bessent said in a television interview on August 20.

But current growth has not delivered the expected fiscal improvement. Bruce Kasman, chief economist at JPMorgan, said earlier this month that given the U.S. economic performance this year, the budget deficit should have fallen, but it has not.

The deficit is now near 6% of GDP, similar to levels during the Biden era. Bessent said last year that this was the highest deficit level in peacetime economic history outside of recessions.

Bessent had also taken an unusual step. After the 30-year Treasury yield hit its highest since 2007, he decided to at least double the Treasury's buybacks of long-term government bonds.

Buying back old debt reduces the supply of long-term bonds in the market, which in theory helps push yields lower. The market also read the move as the Treasury trying to control government financing costs.

Yields did briefly fall, but rose again within a day. That exposed the limits of the policy tools available to Bessent.

Robert Zoellick, former World Bank president and a senior trade and diplomatic official during the George W. Bush administration, said Bessent was using "tactical tools to fight the market because he doesn't hold the fundamental levers, such as deficit spending and tariffs."

Louisiana Republican Senator John Kennedy put it more bluntly: "This is a losing battle."

Bessent's position also risks his standing on Wall Street. As a trader for George Soros, he was part of the team that successfully shorted the pound in 1992.

Zoellick said markets want to believe that those advising the president at least understand the problem, even if they cannot yet solve it.

Meanwhile, Bessent said last month that a deficit reduction plan would be unveiled within days, then later said it would not come for weeks or months.

This month, Trump also promised $5,000 to every American adult if Republicans keep control of the House and Senate in the fall elections.

Joseph Lavorgna, a former Bessent adviser and now chief economist for the Americas at SMBC, said that by even raising the possibility of sending out that money, Trump naturally invites questions about how serious he is about fiscal consolidation.

For the fiscal year ending September 30, the deficit is projected to be at least double Bessent's target. The deficit fell slightly in Trump's first year back in office, but partly because of a one-time change in student loan accounting.

Andy Laperriere, head of U.S. policy research at Piper Sandler and a former House Republican aide, said that if Bessent were president, he might work to cut the deficit to 3% of GDP, but Trump himself has never made that goal a priority.

The Fed becomes another front

White House advisers believe one of Trump's main focuses is pushing the Fed to cut rates, because lower rates directly reduce government interest costs. Weeks after taking office, Trump again pressured then-Fed Chair Powell to lower rates.

Trump took a similar approach during his first term, and his advisers continued to criticize the Fed afterward. In the summer of 2025, Fed officials repeatedly warned that tariffs could bring new price pressures. At the time, after years of fighting inflation, price growth had briefly shown signs of cooling.

The Fed ultimately cut rates three times in a row at the end of last year, citing signs of labor market weakness and judging that tariff-driven price pressures would be temporary.

This spring, Trump appointed Warsh to replace Powell and expected the new chair to deliver lower rates. But this month, the Warsh-led Fed carried out its first rate hike since 2023.

The Iran war and AI investment-driven economic growth were important backdrops to that policy shift. The Fed had expected energy price increases caused by disrupted Middle East shipping to fade quickly, but that did not happen.

Richmond Fed President Barkin said last week that when inflation persists for a while, "you have to look in the mirror and say, 'Inflation seems to have been around for a while, so maybe we should do something.'"

The energy shock may also extend beyond gasoline prices. Diesel is widely used in agricultural machinery and transportation, and former Treasury adviser Lavorgna called diesel "the industrial economy." Barkin said: "It hits everywhere."

Timiraos wrote that after the Fed begins raising rates, the market also needs to reassess how much and for how long the central bank will tighten. That uncertainty itself adds pressure on long-term rates.

As bond yields continued to climb last week, National Economic Council Director Kevin Hassett questioned the unanimous rate hike decision. He argued the Fed may have overlooked recent better inflation data and warned that some officials could continue to "unwisely raise rates" in coming months.

The Trump administration is not entirely unified on this either. Michael Faulkender, a former deputy Treasury secretary now at the University of Maryland, argued that rate hikes cannot solve the main factors currently pushing inflation higher.

"If someone thinks truck drivers will drive fewer trucks and thereby lower diesel prices, or if you think AI companies will be sensitive to a 25 basis point rise in borrowing costs, none of that will happen," he said.

Stephen Moore, an informal Trump adviser, said the rate hike was correct because Warsh also needs to build his own anti-inflation credibility. He believes the real drag on the economy comes from high oil prices.

Riedl argued that the deterioration in inflation and borrowing costs had already appeared before the Iran war began. She noted that when the White House removed tariffs on some goods or eased beef import restrictions to relieve costs, it showed the administration itself recognized the impact of tariffs on prices.

The Iran war further complicates the picture

Now, the U.S. economic outlook depends heavily on how much longer the Iran war lasts. According to people familiar with the matter, before Trump decided to strike Iran in late February, he had seen multiple scenarios on the war's duration and potential economic impact.

But the national security risk of Iran obtaining nuclear weapons ultimately outweighed those economic considerations. The war has lasted longer than many expected. Trump also had not anticipated that gasoline prices would rise so high before the midterm elections.

In March, the war pushed the average U.S. gasoline price above $4 per gallon. Trump said at the time that if the conflict could end within two to three weeks, energy prices would fall sharply.

Now, Trump has repeatedly said the war will end after the midterm elections, which would bring energy prices down. Zoellick said: "People know Trump wants to end the Iran war, but they can see he doesn't know how to end it. And Iran also has a vote."

Timiraos said the persistent energy price shock is becoming another risk for the U.S. economy. The economy had already gone through the Fed's rapid rate hikes in 2022 and regional bank turmoil in 2023.

The AI construction boom is another variable. Large-scale new technology investment can drive growth, but if it ultimately leads to overbuilding, it could also become a source of future economic slowdown.

If the economy enters recession, the government will face a more difficult fiscal environment. Recessions usually widen deficits because government spending rises and tax revenue falls.

Lavorgna estimates that with the deficit already near 6% of GDP, even a mild recession could push it to 8% or 9%. If investors reduce demand for U.S. Treasuries as a result, long-term rates may also fall less during a recession than in the past.

And before the economy deteriorates significantly, Washington has not shown enough willingness to address long-term fiscal problems. Mortgage rates near 7% have not yet pushed Congress to tackle major future deficit sources such as Social Security and Medicare, and neither party wants to move first.

Faulkender said: "It takes both parties jumping off the cliff together." So far, such an agreement has not appeared. Laperriere believes it is "fantasy" to think slightly higher rates can force Congress to act, and that real fiscal consolidation may require greater economic pain.