There’s an article at Barron’s by Brij Khurana that echoes some of what I said in yesterday’s post. Read the whole thing but here are some snippets.
Monetary policy is also becoming less effective in shaping longer-term interest rates. Historically, when the Fed cut short-term rates, long-term yields declined as well. That is no longer true. Since the Fed began its ongoing easing cycle in September 2024, 10-year Treasury yields have actually risen. This reflects resilient economic expansion and a fiscal deficit that has grown so large as to mute the effects of the cuts.
Given these changes, it is worth considering whether the Warsh Fed should prepare markets for more forceful and less predictable rate adjustments ahead.
and
The federal debt complicates the Fed’s ability to achieve its dual mandate of maximum employment and price stability. If foreign investors, who finance a third of U.S. debt, trim their Treasury holdings and the Fed responds by expanding its balance sheet, the dollar could weaken, fueling inflation.
Heavy Treasury issuance creates distortions between government bonds and derivatives linked to them. Hedge funds use substantial leverage to arbitrage these discrepancies. An estimated $1.5 trillion of such trades are outstanding, posing a risk to financial stability. Finally, government spending has helped lift equity markets, supporting wealth-driven consumption and keeping services inflation persistently high.
concluding:
Perhaps the Fed should shrink its balance sheet so the real cost and liquidity of government debt can be fully known. Maybe it should use interest-rate and balance-sheet policy to lean against debt-fueled asset price appreciation, regardless of where that debt originates.
I doubt that will have the results he’s seeking.
If the FOMC were following the Taylor Rule, interest rates would be around 5%. Given the changes in the structure of our economy it might well need to be substantially higher than that to achieve the effects that are needed. My point is not that the Fed doesn’t have the tools to curb inflation. The Fed almost certainly retains the ability to suppress inflation but doing so may require much higher interest rates, a much larger decline in asset prices, and a much deeper economic slowdown than policymakers have recently been willing to accept. My question is whether they have the political will.
Since Clinton no one has cared about our debt. I dont se that changing. I expect a long term game of chicken to see who ends up holding the bag and actually have to do something about it. Tax increases and spending cuts are unpopular so the party in power at that time probably loses the next few elections. For similar reasons I will be surprised if rates go to 5%. Might take care of inflation but no one will want to pay the price.
Steve
It is true that literally no one in Washington cares about the federal debt; they have convinced themselves that it doesn’t matter. Moreover, I, too, do not think the Fed will raise rates. But that doesn’t mean interest rates won’t rise. The buyers of US debt, especially the foreign ones, can impose a rise in interest on US debt by refusing to buy it at the rate offered by the Treasury. I should not be surprised if US debt rates go well above 5%. They might get to 10% or more.
Closely related is oil. The markets have priced oil below $80 per bbl. But that is lunacy. No oil or gas has left the Persian Gulf for three months, and ships leaving the Gulf today (6/17/26) will take a month to reach their destinations. An oil crisis will happen this summer, and a food crisis will follow in the fall. And that assumes the damage to the Gulf’s oil facilities is minimal.
In 1979 it was a much smaller oil crisis that led to high inflation, high unemployment, and massive interest rate increases imposed by the Fed. Variable rate mortgages hit almost 20%, more in some cases.
We are in for a very rough ride. I should not be surprised if Israel attempts to assassinate Trump and Vance.
I don’t know if 4.5, 5, or 6% is the right number, but “higher” is correct. But one must note that so-called core inflation vs a measure including food and energy is divergent right now. The latter has quite a bit of transient policy in it. But there are smoothing techniques in econometrics. Warsh needs to assess where we really are.
But I think the real question is Warshes long term mindset And independence. The “Maestro,” Bernanke and Powell were all easy money disasters. Walsh appears to be different. I guess only time will tell. I can hope.
The first “crisis” will be telling.
What I find scary is that politicians clearly have decided spending/re-election and inflating away the debt are more important or easier than real stewardship. An economically illiterate public is partly to blame. And given that so many pols go to Washington or state houses poor and come out rich does not inspire confidence that they will change. Warsh could be a legend if he is the adult in Washington.
Random afterthoughts:
Clinton didn’t give a wit about balanced budgets other than the famous “my presidency will be determined by a bunch of fucking bond traders?”
1. Clinton fought the budget deal kicking and screaming. And strongly opposed the capgains tax rate reduction that unlocked revenues to make the (political) illusion that he balanced the budget. BTW – Unlocked capgains revenue preceded DotCom revenues, which really came in 1999 and 2000 until it all vaporized.
2. I think the difference between short term and 10 yr rates is instructive. Right now its the 10 year (almost the same as the 30 yr) that really dictates investment thinking and inflation expectations. If the Fed can re-establish its credibility under Warsh then you could see increased investment. And the return of the 30 as relevant.
3. Politicians need a return to tough choices: free beer for everyone as the progressives and their now socialist and communist buddies advocate, or taxes. More taxes, from the current level, are political poison. So its no wonder that the progressives et al have decided to focus on “billionaires” and other juvenile arguments. The rich already pay most of the freight. And if you confiscated their incomes and wealth it wouldn’t finance the government for more than a couple months. But it sells to the man on the street.
The red state/blue state, rural/city divide that currently defines politics is really about a divide in I Produce/You Claim My Efforst as Your Own. It will be interesting.
Good luck Mr Warsh.
When you set aside the partisan rhetoric and actually look at the numbers there isn’t much difference between the two parties when it comes to running up our debt. By most measures the GOP is actually a bit worse but the difference is trivial. Since we have very few people who are willing to look at the actual numbers and mostly rely upon rhetoric, and no one wants to lose an election by addressing the debt issue, it will remain a talking point with partisan rhetoric (see above) until we reach a true crisis point.
Steve
I agree with steve that both parties have blood on their hands.
I believed, long ago, that the Republicans stood for much lower spending. But not today. I guess they got tired of losing elections. Free beer politics sells, and combined with economic illiteracy is dangerous. Which is a reason I blame voters. But the R Party should have held firm.
That said, the Democrat Party historically saw precious few spending programs they didn’t like and the current Democrat Party is run by Progressives, who are nothing short of wild eyed spenders out to “cure” (snicker) every social ill that government has failed to solve in my lifetime and beyond. Free beer on steroids. Today, “ask not what your country can do for you, but what you can do for your country,” would be met with scathing derision from the NYT, WaPo, CNN, Huffington Post etc…..
I do thank steve for noting partisan rhetoric with his (see above), as his bizarre notion that Clinton was a deficit hawk makes one laugh, and wonder how such cult thinking can exist.
Clinton’s Budget Surplus Years
During Clinton’s presidency, the U.S. experienced budget surpluses for the following fiscal years:
Fiscal Year Surplus Amount
1998 $70 billion
1999 $123 billion
2000 $236 billion
2001 $128 billion
The last surplus before the Clinton years was in 1969 per Chat-GPT. I dont have any special knowledge about how much Clinton himself was responsible. Again, if you go back and look at the actual numbers you find that when it comes spending and taxing you dont see that much difference between the parties. The GOP tends to spend a bit less but then they cut taxes more so they end up causing a bit more debt. What is different is that when the GOP is control and cuts taxes they then blame the failure to cut spending on the Dems.
Steve
Steve, there have been two Democratic presidents since Clinton. Neither has run anything resembling a surplus. Is your prescription that Clinton become “President for Life”? There is also a subtlety that sometimes escapes conventional analysis of the Clinton surpluses: they depended on Social Security running large surpluses which were invested (by law) in Treasury bonds which increased the revenue side of the ledger. That doesn’t apply now.
That said I agree that cuts in the personal income tax have been part of the problem. I have opposed every tax reduction for the last 25 years for precisely that reason.
Spending is exceeding revenues. Democrats and Republicans alike need to take ownership of their side of that equation.