Possible Choices of the Federal Reserve:

The Actions of the Federal Reserve Remain the Most Important Variable in the Global Financial Market $NASDAQ Composite Index(.IXIC.US)

1 Setting the Stage: why the triangle looks “impossible”

Policy lever	Desirable outcome	Undesirable side‑effect
A. Increased tariffs	Increase fiscal revenue, suppress high-end industrial chain to China	Push up imported inflation (already evident; see Reuters report)
B. High interest rates	Suppress inflation, support the dollar	Lock in federal net interest at > $1 trillion/year (CBO baseline) for 1 × GDP
C. Reduce deficits	Stabilize debt-to-GDP ratio	Politically difficult to implement; lack of consensus on shutting down government or raising taxes
D. Monetize debt	Reduce nominal interest burden	Counter the Fed's 2% target, which will weaken the dollar's credibility

Over the past 50 years, the U.S. has typically only “pressed” two buttons at a time:

1980s (Volcker + Reagan): A ↓, B ↑, C ↓, D ↓ → End of stagflation, but debt surged

2010s (QE + Obama): B ↓, C ↓, D ↑ → Debt stabilized, dollar intact, moderate inflation

The difficulty in 2025 lies in: A and B advancing in the same direction, creating dual pressure on inflation from “cost push” and “demand pull,” while C and D are constrained politically and institutionally.

2 Core Capability Constraints

2.1 Fiscal-Political Aspect

Bicameral division + 60-vote threshold: Significant tax increases or severe spending cuts are hard to pass.

Depth of the Treasury market: Global USD reserves still exceed 58% (IMF COFER), endogenous demand makes the Treasury inclined to “trade time for space.”

2.2 Federal Reserve's Operational Aspect

Target function remains 2% CPI (BLS latest YoY 2.4%).

H.4.1 Assets 6.73 T, QT space remaining ≈0.3-0.5 T (see previous breakdown) Toolbox:

IOER / ON RRP interest rate adjustment floor

SRF & FIMA repos provide targeted liquidity

Reinvestment cap YCC-lite: Starting in March, reduce the cap on Treasury redemptions to 5B/month (FOMC Minutes) — effectively "softening" QT.

3 Four Feasible Paths of Game Theory

Path	Logic	Necessary Concessions	Probability *
① Maintain USD & Inflation Target High interest rates persist + slight tariffs	Maintain global reserve currency credibility; Fed keeps 2%; fiscal relies on market absorption	Economic growth slows, fiscal interest remains high long-term	45%
② Maintain Growth & Fiscal Early rate cuts + loosen QT	Lower interest expenses; boost investment	Inflation returns > 3%, USD weakens	25%
③ Maintain Inflation & Fiscal Increase taxes/cut spending + high interest rates	Rapidly reduce deficits	Politically unfeasible (election cycle)	10%
④ Maintain USD & Growth Implement quasi-YCC to control long end + expansive fiscal	Smooth interest rate curve; debt rollover	Fed's responsibilities diluted; inflation risk resurfaces	20%

\* Subjective probability, estimated based on 2025 Q1 policy statements, congressional seats, and US Treasury market behavior.

4 The Most Likely Path to Materialize is Path ①

——“Better to have a valuable coin, even if it means slower speed”

4.1 Operational Details

Federal funds target range 5.25-5.50% to be maintained for 2-3 quarters → Exchange time for space to curb tariff-supply chain re-inflation (referred to by Fed officials as the "cruel-to-be-kind" strategy).

QT turns "micro-shrink":

Cap on Treasury redemptions 5B/month, MBS 35B cap automatically falls below the roadmap due to insufficient maturities.

Expected to stop balance sheet reduction by 2025 Q4, stabilizing total assets at 6.4-6.5T.

Treasury increases issuance of 7-20Y notes: Raise average duration to 73 months to smooth peaks.

Tariffs as a "tactical weapon": Focus on EVs, clean energy supply chain, with total tax increase in 2025 ≈ 35-40 billion $ (< 0.6% of total revenue), serving more as a political signal than fiscal benefit.

In conjunction with "friend-shoring" industry subsidies (IRA 2.0): Seek a balance between budget and trade war

4.2 Necessary Sacrifices

Real Economic Growth Rate: The 2025 actual GDP is revised down by CBO from a baseline of 2.2% to 0.4-0.6 pct.

Labor Market: The unemployment rate rises from 3.9% to 4.4-4.6%.

Credit Environment: High-yield bond spreads widen by 80-100 bp compared to the end of 2024; some small banks face renewed pressure from CRE exposure, with the Federal Reserve leaning towards a one-time "targeted exemption" acquisition plan rather than systemic capital injection.

Deteriorating Debt Burden: Net interest/GDP reaches 3.5% in 2026-27, but due to nominal GDP and inflation being suppressed, debt/GDP does not break 110% until 2028.

5 Impact on the Global Economy and Finance: Three Rounds of Shock

5.1 First Round: Strong Dollar + Capital Siphoning

Interest Rate Spread Maintained: Eurozone at 2.75% vs. US at 5.4%, with the dollar index maintaining a range of 105-110.

Capital Flows into US Treasuries and Leading Tech Stocks; emerging markets (especially high foreign debt countries) face passive interest rate hikes, with renewed currency pressure.

5.2 Second Round: Restructuring Trade Chains and Cost Transmission

China-US-Mexico "Triangle": High tariffs on China push "last mile" assembly to Mexico; however, key components are still produced in China, leading to price spillover.

Global CPI Rises by ≈ 0.2-0.4 pct (WTO estimates, could double if decoupling deepens), forcing most central banks, except Japan, to delay interest rate cuts again.

5.3 Third Round: Vulnerable Window After Interest Rate Convergence (2026-2027)

When the Fed finally enters a rate-cutting cycle while the ECB/BoE/BoC have not synchronized—

Dollar Experiences a Correction: Funds flow back to high-yield non-dollar currencies;

US Treasury Curve Steepens: 10Y rates decline by 100-120 bp, but nominal debt remains high relative to GDP, with real interest burdens only slowly receding;

Global Risk Appetite: Growth stocks & precious metals benefit first, while commodities diverge due to tariff barriers (energy/grains weak, copper/rare earths strong).

6 Summary: What is kept, what is sacrificed?

What is Kept	What is Sacrificed
Global Dominance of the Dollar: Adhering to a 2% inflation target, maintaining interest rate spreads, ensuring international investors' trust in US Treasuries; continuing to be the "global safe-haven currency" in the short term.	High Growth Narrative: Willing to let actual GDP decrease by 0.5-1 pct; a moderate cooling of the labor market.
Inflation Anchoring: Stabilizing CPI at 2-3% through high interest rates to hedge against the upward impact of tariffs.	Fiscal Deficit Control: High interest leads to net interest expenses exceeding one trillion, with debt/GDP still crawling.
Monetary Policy Independence: QT slows but does not reverse, maintaining balance sheet flexibility.	Trade Freedom: Long-term tariffs on high-tech supply chains, with globalization retreat viewed as an "acceptable side effect."

Global Impact

Monetary Market: Stronger dollar → capital outflow from emerging markets, again forcing differentiated interest rate hikes.

Supply Chain and Prices: The combined cost of manufacturing relocation and tariffs pushes up global end product prices.

Asset Prices: Polarization of U.S. stock valuations—large AI/platform companies with abundant cash flow enjoy "long-duration dividends"; traditional cyclical stocks face dual pressure from high interest rates and weak domestic demand.

Geopolitical Financial Landscape: More countries accelerate trade denominated in local currencies, increase gold and non-dollar reserves, but a short-term alternative system is hard to establish, and the dollar anchor remains stable.

Conclusion: In the "inflation-dollar-debt" triangle, the U.S. is likely to choose prioritizing the stability of the dollar and inflation, using economic growth and fiscal health as the "cost." This path may avoid a short-term dollar crisis but leaves higher debt accumulation and fragmented global trade for the next decision-makers and the world economy after 2027