Still, I have maintained that market discipline (not least from bond vigilantes) and a still-independent Fed would constrain these stagflationary policies, giving Trump’s moderate economic advisers the upper hand and leading to a de-escalation of trade frictions via negotiations.
That is what has happened. And now that congressional Republicans are negotiating a budget bill that will further increase deficits and debt ratios, the pressure from the market (through higher long-term bond yields) will grow. Trump can either change course or face a spike in bond yields that will cause a politically damaging recession.
It is worth remembering that Trump’s early attacks on the Fed’s independence have already backfired. US stocks sank, bond yields spiked, and Trump stopped threatening to fire Fed Chair Jerome Powell. Though he will be able to replace Powell in 2026, the Fed will remain independent because the chair is primus inter pares (first among equals), rather than an absolute monarch. The Federal Open Market Committee’s overall stance will still reflect the views of its board members.
For now, Powell is doing Trump a favour by not cutting interest rates. The Fed is credibly anchoring inflation expectations in the face of tariff-induced price pressures. By abstaining from rate cuts now, the Fed preserves the option to cut them when the economy weakens toward the end of the year. Trump has no reason to attack Powell, other than to position him as a scapegoat for a potential recession that he himself caused (just as he will blame inflation on Chinese President Xi Jinping’s stubbornness).
See also: Trump's unworkable trade formula
The administration’s restrictions on immigration — and thus on the labour supply — will also backfire. The 2023-2024 period brought robust growth and falling inflation because of a large increase in the labour supply via (partly undocumented) immigration. With a tight labour market, policies that reduce the supply of workers will drive wage growth and inflation, damaging the economy and Trump’s political standing (as pandemic-era inflation did to Joe Biden).
The US needs a steady flow of (preferably documented) immigrants. Trump already sided with Elon Musk on the issue of H-1B visas for skilled workers (a program that Silicon Valley relies on heavily). In defying his nativist MAGA (Make America Great Again) base, he showed that he is not totally clueless about the need to attract foreign talent. Despite the broader damage Trump is doing to the US brand, America remains the top destination for the top 10% of scientific researchers and entrepreneurial talent worldwide, owing to the three-to-fivefold premium in compensation offered in the US.
But cutting research funding and allowing for a brain drain is not consistent with maintaining US dominance in AI and other industries of the future. Here, too, industry feedback and market discipline will lend support to Trump’s cooler-headed advisers. Moreover, mounting legal challenges to the administration’s deportations may eventually push it toward more sensible immigration policies. Otherwise, market discipline will again kick in with a vengeance.
See also: Does Trump really want to sacrifice dollar dominance?
The Trump administration’s efforts to boost US competitiveness and reduce the trade deficit through a weaker dollar will also probably backfire. When the “Liberation Day” tariffs were announced on April 2, the threats to fire Powell and the anticipation of larger fiscal deficits caused the dollar to start falling, a sharp equity-price correction and a spike in bond yields and credit spreads soon followed.
Trump duly backed down on the tariffs, and Powell, and the same discipline will force a fiscal adjustment, as we have seen in other advanced economies and emerging markets in recent years.
The idea of a “Mar-a-Lago Accord” to orchestrate an orderly weakening of the dollar is far-fetched, bordering on lunacy. Key trading partners — not least China — would never join, and America’s own friends and allies would baulk.
The more that markets come to expect a sudden dollar devaluation, the spikier bond yields will become. Proposals to convert non-residents’ short-term Treasury holdings into long-term securities wouldn’t even work in theory, let alone in practice. Weakening the dollar through capital controls on inflows — a tax on foreign holdings of Treasuries — will almost certainly drive up long-term rates and undermine the economy. Market vigilantes simply will not allow such unsustainable policies to be pursued for long.
Finally, while the administration’s assault on the rule of law has been quite aggressive, US democratic institutions — starting with independent courts and judges — and civil society remain robust, and should be able to constrain the most extreme policies. Again, one must not underestimate the power of market discipline here. In other countries — like Turkey — where autocrats have undercut the rule of law, the reaction from bond and other markets has been unforgiving.
Ultimately, either Trump will back down from his stagflationary policies to concentrate on pro-growth measures, or financial stress and a recession will cause the Republican Party to lose the midterm elections in 2026.
One hopes that Trump does heed the market and stops acting on his worst instincts. He should recognise that homegrown technological innovations promise to increase America’s potential growth substantially. He just needs to get out of his own way. — © Project Syndicate, 2025
Nouriel Roubini, a senior adviser at Hudson Bay Capital Management LP and Professor Emeritus at New York University’s Stern School of Business, is the author, most recently, of Megathreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them (Little, Brown and Company, 2022)
