Don't underestimate Trump's determination – How will the U.S. "cut interest rates"?

The Federal Reserve's monetary policy meeting will be held this month, with the current market focus on whether the Fed's independence will be compromised and whether the upcoming interest rate cuts will have a "political" tint.

Recently, Peter Tchir, the head of macro strategy at Academy Securities, stated that these concerns have fostered a widespread expectation: even if the Fed initiates rate cuts, it will only lower short-term rates, while long-term yields will face upward pressure due to inflation concerns. Currently, this view has become mainstream in the market and is guiding many investors' positioning.

However, Tchir believes that investors may not have sufficiently "stepped outside conventional thinking," thereby underestimating the government's plan to lower rates. In addition to traditional monetary policy, the U.S. government may adopt a series of unconventional measures, including adjusting the Fed's balance sheet, changing the way inflation data is calculated, and even re-evaluating gold reserves, to achieve its goal of lowering long-term rates.

Tchir added that these potential policy options go beyond mere rate cuts and may involve coordinated operations between the Fed, the Treasury, and even accounting standards.

"Political" rate cuts or data-driven rate cuts?

Concerns about "political" rate cuts may overlook the economic rationale behind the cuts themselves.

The article states that if there is sufficient data-driven justification for significant rate cuts, then the market's panic over long-term rates may not materialize.

Tchir pointed out that signs of economic weakness had already appeared before officials began to disagree on the issue of rate cuts. For example, at the July Fed meeting, two officials had already expressed dissent regarding the decision not to cut rates, and the subsequently released June employment data was significantly revised downward; Powell's speech at Jackson Hole also exhibited a dovish stance.

These signs indicate that the reasons supporting rate cuts within the Fed may be more substantial than what the meeting minutes revealed.

Tchir believes that if subsequent employment data fails to show strong improvement, a 50 basis point rate cut in September would be entirely "reasonable" and should not simply be viewed as politically driven. If rate cuts are seen as justified by the market, then the "alarm" that investors expect—namely, the sell-off of long-term bonds—will be less likely to materialize.

Diminishing effectiveness of traditional rate tools

Tchir argues that another reason the U.S. government is considering unconventional options is that the effectiveness of traditional monetary policy tools is diminishing.

The article explains that merely adjusting the front-end federal funds rate to influence the economy has a "long and variable" lag in its transmission path, making its effects difficult to assess. Within months of policy implementation, any factors such as trade wars or geopolitical conflicts could alter the economic trajectory.

Moreover, since the era of zero interest rate policies, many businesses, individuals, and municipal bond issuers have locked in long-term low rates, significantly reducing their sensitivity to changes in front-end rates. This means that the effectiveness of transmitting monetary policy through short-term rates is no longer what it used to be.

What might be in the "toolbox" of unconventional policies?

If the effects of traditional tools are not significant, the government may open its unconventional policy "toolbox" to directly intervene in long-term interest rates.

• Aggressive Rate Cuts with Forward Guidance

One possible strategy is to "achieve success in one fell swoop." For example, a one-time significant rate cut of 100 basis points, while committing to keep rates unchanged for the next few quarters unless there is a significant change in data.

This move aims to quickly dispel market speculation about the future path of rate cuts. A one-time rate cut of 100 basis points would require a significant steepening of the yield curve to keep the 10-year U.S. Treasury yield above 4%, which may be a challenging task for "bond market vigilantes."

• Attacking Inflation from a Data Perspective

Another strategy is to directly challenge the validity of inflation data. Currently, the housing cost component, which has a significant weight in the U.S. CPI, is artificially inflating inflation data due to its lagging algorithm for "owner's equivalent rent" (OER).

Tchir points out that a new indicator compiled by the Cleveland Fed shows that real rent inflation has returned to normal levels, far below the housing inflation in the CPI. By emphasizing these data discrepancies, the U.S. government can effectively weaken market fears of inflation and clear the way for rate cuts.

• Restarting "Operation Twist"

The most core measure may be to restart "Operation Twist" (OT), by simultaneously selling short-term U.S. Treasuries and buying long-term U.S. Treasuries to lower long-term interest rates.

Currently, the Federal Reserve's balance sheet is heavily tilted towards short-term debt, holding about $2 trillion in bonds with maturities of 7 years or less, while only $1 trillion in bonds with maturities of 15 years or more. Analysts envision that the Fed could sell about $1.2 trillion of bonds with maturities of 3 years or less and use the proceeds to purchase long-term bonds with maturities of over 20 years.

Tchir notes that this move would nearly double the Fed's holdings in the ultra-long bond market, and the purchasing power would be sufficient to influence or even control about 50% of the freely traded ultra-long bond market, thereby directly lowering long-term yields.

• Other Potential Options

Other more disruptive options may also be considered.

For example, Yield Curve Control (YCC), although there is no precedent in the U.S., has been practiced in Japan, and for a government accustomed to "setting prices" through tariffs, setting a cap on yields is not unimaginable.

Additionally, revaluing U.S. gold reserves is also an option. It is estimated that if the U.S. official gold reserves were revalued at market prices, it could generate about $500 billion in accounting gains. Although this move is complex, it can effectively divert market attention and potentially provide funding for other investment plans.

Tchir adds that this move could lead to a weaker dollar, but for a government aiming to improve the trade deficit, it may be "a feature rather than a flaw."