The Trump administration digs into the Federal Reserve's "hidden third mission," with long-term interest rate control becoming a new focus

The Trump administration is pushing "moderate long-term interest rates" to the core of monetary policy by citing a long-ignored provision in the Federal Reserve's charter, which could overturn investment rules that Wall Street has followed for decades.

The latest signal of this move comes from Trump's nominee for the Federal Reserve Board, Milan. He referenced the provision in the Federal Reserve's charter that "pursues moderate long-term interest rates" during a congressional hearing, sparking widespread discussion among bond traders.

Previously, the market generally believed that the Federal Reserve had only two "dual mandates": "price stability" and "maximum employment." This statement not only made the market aware of the little-known "third mandate" in the Federal Reserve's charter but was also seen as a clear signal that the Trump administration is attempting to use the Federal Reserve's own regulations to provide "legitimacy" for intervening in the long-term bond market.

Although the market currently expects the Federal Reserve to cut interest rates due to a weakening labor market, causing long-term yields to fall, the focus of Washington's top officials on long-term interest rates is enough to raise the vigilance of market participants and force them to incorporate this potential policy shift into their investment considerations.

"Third Mandate" Emerges

The Trump administration's reshaping of the Federal Reserve is accelerating, and the aforementioned statement is a key step in this process.

According to a report by Andrew Brenner, Vice Chairman of Natalliance Securities LLC, on September 5, the Trump administration "found this vaguely defined provision in the Federal Reserve's original documents, which allows the Federal Reserve to have greater influence over long-term interest rates."

He emphasized that while this is not the current trading theme, it is definitely a topic that investors need to ponder deeply. This move also highlights Trump's willingness to break decades of institutional norms to serve his own goals, undermining the Federal Reserve's long-standing independence.

The focus of Washington's top officials on long-term interest rates is not unfounded. In the economy, long-term Treasury yields largely determine the costs of trillions of dollars in debt, such as mortgages and commercial loans. U.S. Treasury Secretary Becerra also cited the Federal Reserve's three statutory objectives in a column for The Wall Street Journal, criticizing the Federal Reserve's "mission drift." Lisa Hornby, Head of U.S. Fixed Income at Schroders, stated in an interview that stimulating the housing market "is clearly the top priority of this administration."

Potential Policy Tools and Market Response

What means the Trump administration and the Federal Reserve might use to control long-term interest rates has become a hot topic of discussion in the market. Analysts are exploring various possibilities and adjusting their investment strategies accordingly.

George Catrambone, Head of Fixed Income at DWS Americas, believes that if long-term yields remain high after consecutive interest rate cuts by the Federal Reserve, it could trigger policy action. He is confident that whether led by the Treasury or supported by the Federal Reserve, they will ultimately "achieve their goals in some way." Catrambone mentioned that he has been converting maturing short-term Treasury bonds into 10-year, 20-year, and 30-year bonds in recent months, which is a "non-consensus" position Possible policy options include: the Treasury selling more short-term Treasury bills while repurchasing longer-term bonds. More aggressive measures could involve the Federal Reserve purchasing bonds through quantitative easing (QE), although Bessenet has expressed opposition to past QEs, he also supports initiating QE in a "real emergency." Another option is for the Treasury to collaborate with the Federal Reserve to utilize its balance sheet to absorb longer-term bond issuances.

Daniel Ivascyn, Chief Investment Officer of Pacific Investment Management Company (PIMCO), pointed out that while the likelihood is currently low, if the ultimate buyer—the Federal Reserve—decides to step in to set a cap on interest rates, the risk of shorting long-term bonds will increase. PIMCO is currently still underweight in long-term debt but has begun to take profits on positions aimed at outperforming short-term securities.

Historical Lessons and Inflation Risks

Historically, the Federal Reserve has intervened in long-term interest rates multiple times, with the most notable examples during World War II and post-war, as well as the "Operation Twist" in the early 1960s. During the recent global financial crisis and the COVID-19 pandemic, the Federal Reserve also suppressed long-term yields through large-scale asset purchases.

However, Gary Richardson, an economics professor at the University of California, Irvine, and a Federal Reserve historian, pointed out that these past actions primarily occurred during wartime or periods of great depression:

"Those reasons do not apply now. We are not in a great war, nor are we in a massive depression. Now, it feels more like Trump wants to do this."

The market remains vigilant about the potential negative impacts of such interventions, especially inflation risks. Institutions like Carlyle Group have warned that when inflation rates remain above target levels, attempts by the Federal Reserve and the Treasury to suppress long-term rates could backfire. In January of this year, expectations that the Trump administration would push for more stimulus measures to boost economic growth briefly drove the 10-year U.S. Treasury yield to a year-to-date high of 4.8%.

Definition of "Moderate" and Sovereign Debt Costs

The phrase "moderate long-term rates" in the Federal Reserve's charter is itself highly ambiguous. Mark Spindel, Chief Investment Officer of Potomac River Capital, believes that the ambiguity of this term can be used to "justify almost anything."

He noted that, by historical standards, the current 10-year U.S. Treasury yield at around 4% is well below the average of 5.8% since the early 1960s, suggesting that there is no need for any unconventional policies. Spindel is purchasing short-term Treasury Inflation-Protected Securities (TIPS) to hedge against the risk of the Federal Reserve losing its independence.

Vineer Bhansali, founder of asset management firm LongTail Alpha, linked this action to the ever-expanding U.S. national debt. With Congress passing the latest budget to extend Trump's tax cuts, the U.S. budget deficit is expected to remain at a high level of over 6% of GDP. As of September 9, the total U.S. national debt has reached $37.4 trillion Lower interest rates will help reduce the cost of financing this massive debt.

Bhansali believes that since the government cannot address the debt issue at the fiscal level, "they must resolve it at the Federal Reserve level, as that is the only option. Therefore, it is expected that the Treasury Secretary will manipulate long-term interest rates." He stated that the Trump administration seems willing to take on higher inflation risks, and "the Federal Reserve will ultimately have to heed the wishes of the president and the Treasury authorities, even if inflation rises."