MNI INTERVIEW:Fed Cuts Have Limited Impact On Long Bond Yields

Federal Reserve rate cuts will offer little relief on elevated long Treasury yields, but the U.S. administration has several tools to lower borrowing costs, starting with a ramp up in bill issuance mid-next-year and capping long term debt supply, former New York Fed trader Joseph Wang told MNI.

"Japan is doing this right now, reducing issuance at the long end, and I expect Treasury to do that as well. They could easily not increase coupon issuance and continue to finance the fiscal deficit by increasing the share of bills," Wang said in an interview. "That's an easy thing they could do that would have a pretty big effect on keeping long-dated yields lower." 

Treasury Secretary Scott Bessent has said he and President Donald Trump are focused on bringing down longer-dated rates. They've agitated for cuts on the front end, with newly installed Fed Governor Stephen Miran calling on the FOMC to slash rates to under 3% by year-end, hoping the impact ripples across the yield curve.

ROUTE TO LOWER RATES

But anticipated Fed cuts have had little impact on long yields because market pricing is driven by a "materially higher" neutral rate compared to pre-pandemic and a larger fiscal deficit that's boosted the supply of longer dated Treasuries, said Wang, author of research blog Fedguy.com. 

Benchmark rates are expected to bottom at 3% in this cycle, above the 2019 high of 2.5%. Fed projections are less aggressive than the market, adding upside risk to yields, he said. 

With ramped up debt issuance from Washington, the 10-year yield is also trading increasingly higher relative to the 10-year swap, leaving a historically negative 50bp spread, Wang noted. That makes dealers less willing to buy bonds. 

"Because we’re issuing so much Treasuries, the dealers need that spread to compensate them for holding that on their balance sheets. That's the regulatory cost."

LEVERAGE RATIO

The Fed's lead bank regulator, Governor Miki Bowman, a Trump appointee, is leading the charge on relaxing the leverage ratio, which the agencies estimate would unlock up to USD1.1 trillion in available capacity for bank reserves or Treasury securities. Future discussions at the Fed over the composition and maturity profile of its asset holdings could also have some effect.  

But the U.S. central bank also isn't likely to intervene directly to cap long-end rates by buying bonds as part of QE, Wang said.

"You have to have a big rise in yields like the UK before policymakers jump in to do that. It doesn’t happen unless events force it to happen," he said. "This administration has shown a strong degree of expertise in managing the financial system, and it looks like they're going to have the help of the Fed. The path to get to lower yields is a little different in my view." (See: MNI: Warsh Wants Fed Out Of U.S. Treasury's Business)

For now, fears over a loss of Fed independence are not showing up in market-based measures of inflation expectations, Wang said, adding, "But even if you lose Fed independence, it doesn't necessarily mean you have high inflation. Independent central banks is something many countries didn't have until the '90s, so the link between losing it and suddenly becoming Turkey is just not very strong."