Next Fed Chair - short and long rates

[Mephistopheles]

I think it's highly likely that the next Fed Chair follows Trump's wishes of lowering rates. So it seems obvious that short term rates will drop in the next couple of years. I'm wondering if they can pull this off for long term rates as well. QT has stopped. Are they going to go back to QE in a major way to drive down rates? Not an expert on macro, so am curious to know what sort of power the Fed has via QE. And how would this pair in a high inflation scenario? We can also assume the deficits will remain large and maybe get larger in a slowdown. Would love to hear everyone's thoughts especially @wabuffo, our resident expert on this matter!

[wabuffo]

So it seems obvious that short term rates will drop in the next couple of years.

 

I don't think short-term rates matter much (within a reasonable range).   US households and non-financial businesses, in aggregate, are currently positively geared to rates.  IOW - they benefit more from rising short-term rates through increased income vs lowering rates (since most household liabilities are fixed in the short-term).

 

I'm wondering if they can pull this off for long term rates as well. QT has stopped. Are they going to go back to QE in a major way to drive down rates?  Not an expert on macro, so am curious to know what sort of power the Fed has via QE.

 

I doubt it.  The Fed isn't going to expand its balance sheet.  And the US Treasury is less concerned with managing duration and more concerned with supplying the right quantities of bills, notes, and bonds that the private sector needs.   The yields at the long end will be a function of what the market expects for inflation and economic growth.  Call inflation at 2.5% and real growth at 2% & you can probably expect a 10-year at 4.5%?  I dunno - that's just my SWAG.

 

And how would this pair in a high inflation scenario?

 

I guess I'm in the minority that thinks inflation is not going to be a problem.  Wages, rents, and energy costs are flat to declining right now.  These would be the major inputs to any re-inflation scenario so its hard to see what drives inflation higher from here, IMHO.

 

We can also assume the deficits will remain large and maybe get larger in a slowdown.

 

We all need to learn to love deficits - for the owner of the reserve currency, the rest of the world needs to run trade surpluses with the US in order to obtain US dollars and US dollar assets.  So one needs a large deficit to US GDP than most people have thought possible to accomodate both domestic + foreign demand for US Treasuries.  And the US is finally running a decent sized deficit that meets that demand.

 

Bill

 

Edited December 30, 2025 by wabuffo

[gfp]

1 hour ago, wabuffo said:

the rest of the world needs to run trade deficits to obtain US dollars and US dollar assets.

 

trade surpluses, no?

[wabuffo]

trade surpluses, no?

 

yeah - got turned around mid-sentence (trade deficits from US POV, trade surpluses for ROW).  I'll fix it, thanks!

 

Bill

[Mephistopheles]

1 hour ago, wabuffo said:

I doubt it.  The Fed isn't going to expand its balance sheet.  And the US Treasury is less concerned with managing duration and more concerned with supplying the right quantities of bills, notes, and bonds that the private sector needs.   The yields at the long end will be a function of what the market expects for inflation and economic growth.  Call inflation at 2.5% and real growth at 2% & you can probably expect a 10-year at 4.5%?  I dunno - that's just my SWAG.

 

 

Why do you think not? Let's say you have a Fed that wants to bring down long term rates, this is the way to do that right? Now if is 2.5 and growth 2, perhaps it won't be as effective, but that was my original question. Let's say they do QE at post GFC levels purely for the purpose of driving down rates...what would happen in today's world?

[gfp]

I don't think QE will be effective at driving down long rates more than a few basis points, all else equal.  If they want to target MBS spreads or something like that they can have an impact on that specific spread but long rates are going to be set off growth and inflation expectations.  The best way to get low long term treasury rates is to have a horrible economy.

[wabuffo]

Why do you think not?

 

Because as gfp notes - I think its only marginally effective at bringing down rates.   Secondly, to buy more bonds, the Fed will have to add more reserves to the banking sector.  As we've seen those reserves if they are not needed or wanted by the banks, come right back to the Fed in the form of reverse repo.   So the Fed ends up sucking and blowing at the same time.  

 

Bill

[Mephistopheles]

Thanks guys, I had imagined that it's harder than it seems (to influence long rates) but this clarifies.