The Trump administration reiterates the Federal Reserve's "third mandate," is the U.S. Treasury market about to change?

For several generations on Wall Street, it has been an obvious fact: the Federal Reserve has a "dual mandate" to maintain price stability and achieve full employment. This mandate determines how it sets interest rates, and this principle has been repeatedly followed from Alan Greenspan to Jerome Powell.

Therefore, when Stephen Miran, the new Federal Reserve governor nominated by Trump, mentioned a third goal—that the Federal Reserve must also "maintain moderate long-term interest rates"—analysts began to explore its significance and potential impact. In fact, the "third mandate" mentioned by Miran belongs to the traditional third goal of the Federal Reserve.

Andrew Brenner, head of international fixed income at NatAlliance Securities, stated that the significance of this move for financial markets is obvious—and concerning—because it could disrupt portfolios. Brenner believes that Miran, who is known for the Mar-a-Lago agreement and has just become a Federal Reserve official, mentioning the "third mandate" in his congressional testimony is the most obvious sign so far that the Trump administration intends to use monetary policy to influence long-term bond yields, using the central bank's own charter as a cover.

This also highlights that Trump is trying to break decades of institutional norms to undermine the long-standing independence of the Federal Reserve to serve his own goals.

Brenner wrote in a report on September 5: "The Trump administration 'found this clause in the original documents of the Federal Reserve, which is not clearly stated, allowing the Federal Reserve to have a greater impact on long-term interest rates.' This is not a current trading strategy, but it is indeed worth our consideration."

Currently, there are no such policies in place, nor are they needed in the near term, as yields on U.S. bonds of all maturities are gradually falling to their lowest levels of the year, and the deteriorating job market paves the way for further rate cuts by the Federal Reserve. Moreover, recently, the "third mandate" has been more viewed as a natural outcome in the process of controlling inflation management.

However, some investors have indicated that they are already fully aware of the long-term interest rate factor, and thus have taken into account the possibility of some action when assessing the bond market. Other investors have warned that if non-traditional measures to limit long-term interest rates gradually become part of policy, it could have adverse effects, especially on inflation, making debt management and the Federal Reserve's work more difficult.

While the process of setting the short-term target interest rate by the Federal Reserve often receives much attention, it is actually the long-term U.S. Treasury yields set in real-time by traders around the world that determine the interest levels paid by the American public on trillions of dollars in mortgages, corporate loans, and other debts.

U.S. Treasury Secretary Mnuchin frequently emphasizes the importance of long-term interest rates to the U.S. economy and the issue of housing costs. Like Miran, Mnuchin cited the three statutory goals of the Federal Reserve in a recent commentary and criticized the central bank's "overreach."

Impact on Investment Portfolios

George Catrambone, head of the Americas Fixed Income division at Deutsche Bank, stated that a potential trigger for action could be a situation where long-term interest rates remain high even after multiple rate cuts by the Federal Reserve.

Catrambone said, "Whether the funds come from the Treasury, are supported by the Federal Reserve, or a combination of both, they will achieve this goal in some way, and this reaction mechanism will ultimately take effect." In recent months, he has been converting maturing short-term U.S. Treasury bonds into 10-year, 20-year, and 30-year bonds, admitting that "this is a position contrary to mainstream views."

Among the possible measures mentioned in the bond market aimed at lowering or at least limiting long-term interest rates are: the U.S. Treasury issuing more short-term bonds and increasing repurchase operations for longer-term bonds. Further measures would involve the central bank purchasing bonds as part of quantitative easing, although Bessenet has detailed the negative impacts he believes past Federal Reserve quantitative easing policies have caused. However, the Treasury Secretary supports implementing quantitative easing in "truly urgent situations." Another option is for the Treasury and the Federal Reserve's balance sheets to work together to absorb longer-term bond issuances.

Although this possibility has become very slim at present, once final buyers intervene and set interest rates, it will undoubtedly increase the risk of betting on a decline in the long-term bond market, at least to some extent.

Daniel Ivascyn, Chief Investment Officer at Pacific Investment Management Company, stated, "If a less independent Federal Reserve decides to restart quantitative easing, you will suffer significant losses in terms of the yield curve; or if the U.S. Treasury becomes more aggressive in managing the yield curve, the situation will be similar." This bond giant still holds an underweight position in long-term bonds, although it has taken profits from positions aimed at benefiting from the strong performance of short-term securities, which have been very beneficial for its best-performing funds this year.

Current Context Not Applicable to "Third Objective"

The Trump administration's attempts to lower long-term interest rates will replay past scenarios, especially during and after World War II. As early as the early 1960s, the Federal Reserve implemented "Operation Twist," which aimed to lower long-term interest rates while keeping the issuance of short-term bonds unchanged.

During the peak of the global financial crisis, the Federal Reserve began purchasing mortgage-backed assets on a large scale, later expanding the scope to U.S. Treasury bonds, aiming to lower long-term interest rates and stimulate the economy. By 2011, the Federal Reserve introduced another form of "Operation Twist." Compared to this, earlier quantitative easing policies were much smaller in scale. During the COVID-19 pandemic, the Federal Reserve purchased a large amount of corporate bonds, with the scale far exceeding any previous period.

Gary Richardson, an economics professor at the University of California, Irvine, and a historian of the Federal Reserve, stated, "In the past, the Federal Reserve has indeed done what Trump is now trying to do, and Congress has allowed the Federal Reserve to do so." However, this mainly occurred during wartime or economic crises He said, "These situations no longer apply. We are not in a large-scale war, nor are we experiencing a severe economic recession. Right now, it's like what Trump wants to do."

If the U.S. Treasury and the Federal Reserve take more aggressive measures to try to lower long-term interest rates, it could backfire, especially in a situation where inflation remains persistently high and above target levels, as institutions like Carlyle Group have warned. The prospect of the Trump administration pushing for more stimulus measures to drive economic growth led to the 10-year U.S. Treasury yield reaching its peak of 4.8% in January this year.

On a broader level, there is also a question of how to define "moderate long-term interest rates." By historical standards, the current 10-year U.S. Treasury yield is close to 4%, which, even at this year's high, is still well below the average of 5.8% since the early 1960s. Data shows that this situation indicates there is no need for any special policy measures.

Mark Spindel, Chief Investment Officer of Potomac River Capital, stated, "What 'moderate' means for a number is indeed difficult for me to define, but it's a bit like the 'Goldilocks' principle here. We haven't set it too high or too low."

For Spindel, the ambiguity surrounding the expression of medium- to long-term interest rates means that this level of interest rates could be used to "provide justification for almost anything." He mentioned that he is buying short-term U.S. Treasury Inflation-Protected Securities (i.e., "TIPS") to guard against the risk of the Federal Reserve losing its independence, so that he can "have a hedge against inflation" if the Fed becomes politicized.

As government deficits continue to swell, lowering interest rates across the yield curve will help reduce the cost of financing the growing debt burden. According to collected data, as of September 9, the total U.S. national debt has reached $37.4 trillion. The recently passed budget plan extending Trump's tax cuts is expected to keep the U.S. budget deficit at a high level of over 6% of Gross Domestic Product (GDP).

Besen mimicked the approach of former U.S. Treasury Secretary Yellen, attempting to increase the sales of short-term bonds while keeping the sales of long-term bonds unchanged, while stating that the current level of yields is not favorable for taxpayers to sell long-term bonds Vineer Bhansali, founder of the asset management company LongTail Alpha, stated: "The cost of debt and debt repayment poses a constraint on the government, and they must take measures to address this issue, but cannot intervene at the fiscal level. Therefore, they must take action at the Federal Reserve level, as this is currently the only feasible approach. And now, with the long-term interest rates being manipulated by the Treasury Secretary to align with lower levels, this is inevitable."

Bhansali noted that for those concerned about accelerating inflation, this risk seems to be one the government is willing to take. "The Federal Reserve will ultimately act according to the wishes of the president and the Treasury Department—even if it means higher levels of inflation."