The Fed’s Third Mandate means Yield Curve Control is Coming

All eyes are on the Federal Reserve's interest rate policy, but that might just be a distraction from the main thing you should be paying attention to, which is their balance sheet. And this is because of the Federal Reserve's third mandate that has more control over the bond market, at least according to Stephen Moran, who cited in a congressional testimony that the Federal Reserve must pursue moderate long-term interest rates. Now, if you're sitting there wondering who the heck is Stephen Moran, well, he's the newest member of the Federal Reserve, just recently confirmed by the Senate in a vote 48 to 47. He was confirmed just hours before the Federal Reserve's two-day FOMC meeting began. So with the highlight that Stephen Moran put on the Fed's third mandate, what in the world is the Fed's third mandate? Well, we're all familiar with the dual mandate, and to be honest, I don't know why that phrase ever became popular. Let's go back and look at the original text, and you'll find there are not two mandates there, there are three. Right now, we are looking at a copy of the Federal Reserve Act of 1977. We're gonna scroll down on the first page to section 2A. The Board of Governors of the Federal Reserve System and the FOMC shall maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production. Why? So as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates. Those are the three goals, the three things that Congress says to the Federal Reserve, this is the reason you exist, and this is why we allow you to continue to exist, and this is now your job, what you are supposed to do and pursue. Maximum employment, stable prices, and moderate long-term interest rates. And it is that third one that is going to drive the next decade plus. Before we get into how that will happen though, before we get into how the Federal Reserve moderates long-term interest rates, I do wanna touch on the initial opening sentence of the Federal Reserve Act of 1977, that they are to maintain long-run growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production. Now, in a hypothetical world that didn't exist, imagine the number of dollars, the supply of money was exactly constant. It couldn't change, it couldn't increase or decrease. In this world, we are creating more houses, we are creating more food, we are creating more energy efficiency, we are creating more things, more stuff, there is innovation everywhere, which means you'd have the same amount of money chasing more stuff, more goods and services, more wealth. The necessary result of that would be that prices would have to adjust downwards. Just like if you have more money, inflation, money printing, chasing the same amount of goods and services, you have inflation, like we saw in 2020, 2021, the opposite is true as well. If you have the same amount of money chasing more goods and services, you have deflation. But the Federal Reserve is tasked specifically with maintaining the growth of the monetary and credit aggregates commensurate with the economy's long-run potential to increase production. In other words, the monetary and credit aggregates, the money supply, the growth of spending power in the economy should grow roughly at the same rate as the increase in production. In a world without intervention, we would see prices declining and the cost of living getting cheaper over time and the purchasing power of your money going up. But because of the intervention that Congress has told the Federal Reserve to do to your money, you lose out on those cost savings. You lose out on getting wealthier over time. That purchasing power is siphoned away from you to the government, even if prices stay the same. But just to make sure they're doing a good enough job at that, stable prices means 2% inflation, which means prices aren't even staying the same for you. They're going up. This is why the Fed exists, to transfer purchasing power as efficiently as possible from the entire economy to the government. Okay, so now let's talk about how they do that with moderate long-term interest rates. The Trump administration and Treasury Secretary Scott Besant have been pushing the importance of long-dated rates going down for a long time, specifically for economic growth and things like home ownership. Long-term interest rates would be things like the 10-year yield or longer. Now, the long-term interest rates matter a lot more to the economy than the short-term interest rates. Yes, if short-term interest rates go up or down, that affects your high-yield savings account. That affects the yield that you get on your money market funds. But it doesn't have that much to do with overall production and long-term investing in the United States. The 10-year yield is a much better benchmark. The reason why is because if I, just a normal person, have money that I want to put to work, but I want to put it in something really safe, I'm gonna consider treasuries because they are looked at as the risk-free rate. So I could give my money to the U.S. government for 10 years and get 4% per year on that. Now, there's other people that want to borrow my money other than the U.S. government. So I could look at Bank of America, I could look at Amazon, I could look at Apple, I could look at my friends, I could look at somebody who wants to borrow for a mortgage or a car. And if they all also want to borrow from me at 4%, of course I'm not gonna give them my money. They don't have the power of violence and taxing in order to collect my money in a worst-case scenario. They might default. The U.S. government at 4% is never gonna default. At the end of the day, even if they can't tax it, they can still print it. So I know I'm gonna get the 4% on my money for the next 10 years if I give it to the government. Which means if I am going to give my money, lend it to somebody else for the next 10 years, I'm gonna need a higher rate than 4%. Maybe 5%, maybe 6%, who knows? And given the fact that mortgages are usually refinanced or paid off within 10 years, auto loans are creeping up next to 10 years, business loans, commercial real estate, all these loans have an average maturity somewhere around 10 years, the 10-year yield is a fantastic benchmark for determining what interest rates are for the rest of the economy. In other words, they set a floor, and any risk added on top will increase yields or interest rates. So now imagine that the U.S. government needs to borrow so much using 10-year bonds only that it drives interest rates all the way up to 9% or 10% where they've been before. That means all other borrowing in the economy would have to, again, be higher than that, maybe 11%, 12%, 13%. Because if I can get a risk-free 10% from the U.S. government for 10 years, I'm gonna demand a way higher interest rate from everybody else. On the other hand, if yields on the 10-year drop to 3% or 2.5% or lower, then there's room for interest rates across the rest of the economy to drop as well. It won't necessarily push them lower, but it could allow for them to go lower. Because if I can only get 2.5% from the U.S. government, that might not be good enough for me. I might choose the extra risk for the extra return. That frees up a bunch of capital, a bunch of lending to go and be productive in the actual economy instead of just going to the government. All this extra demand to lend to the private economy can push yields across the economy lower. But here's the thing. The Federal Reserve does not control the 10-year. They only control overnight rates between banks. So when the Fed cuts rates, it doesn't necessarily have any influence on things like the 10-year, which is why last time they cut rates, which was in September of 2024, and then they ended cutting rates January of 2025, it actually made the 10-year yield rise. It went from 3.6% all the way up to 4.8%. Now, this might seem counterintuitive, but it's just about inflation expectations. When the Fed cuts overnight interest rates, that makes borrowing for the government easier as long as they're borrowing short-term debt. It makes it cheaper. They're able to borrow and spend more money into existence. That increases the money supply. That's more money chasing the same amount of goods and services. That makes prices go up. And if prices are gonna go up, lenders across all other forms of debt are gonna demand a higher interest rate to compensate themselves for the loss of purchasing power, which is why when the Fed cut rates starting last September, it made other forms of interest rates actually get more expensive. So the Fed cutting interest rates isn't gonna cut it, pun intended, which brings the question, how do they actually maintain moderate long-term interest rates according to their third mandate? The answer is their balance sheet. Treasury Secretary Scott Besant has talked about how he doesn't like the negative effects from the Fed doing QE, although he said that it's still okay in true emergencies. And here's the thing. A sovereign debt crisis would probably be considered a true emergency by the Treasury Secretary. So option one is that we see the Federal Reserve resume QE and their balance sheet starts increasing again. You can think of the Federal Reserve's balance sheet like their brokerage account. They buy assets. The Fed buys mortgage-backed securities and treasuries. These are forms of debt, and when this debt gets paid back, they take some of those dollars that were paid back to them and buy new debt, in other words, roll it over, loaning it back out into the economy. But when that balance sheet is declining, that means some of those dollars that are getting paid back to them, they are not rolling that over and reinvesting it. Those dollars are just ceasing to exist, which means the size of their balance sheet goes down. In other time periods, when the balance sheet is rising, it means they are creating money, printing money into existence to go out into the economy, into the market, and buy up assets. They're lending cash into existence. If the Federal Reserve is tasked with maintaining moderate long-term interest rates, and that gets interpreted as the 10-year yield going down, the easiest way to accomplish this would be for the Federal Reserve to go out into the open market and just start buying up 10-year treasuries with newly printed money. That drives the price of 10-year treasuries up, which drives the yield lower. But that's not the only option. The Treasury itself could borrow at the short end with T-bills even more and use that extra borrowing to do a bunch of buybacks for longer-dated bonds, like 10-year. Because right now and forever, the government always spends everything that it taxes, spends even more, and borrows the difference. That's called running a deficit. That's why we have such a large national debt. And so this proposes that they would borrow even more at the short end, like six-month T-bills or one-year T-bills, and use that extra money they're borrowing in order to pay back, buy back longer-term bonds. This would be like you opening up some new credit cards, getting a cash advance in order to pay off a longer-term personal loan. Your total debt would stay the same. You're just transferring some of that longer-term debt into shorter-term debt. This would be helpful in the short run. It'd be like a Band-Aid for the economy because the Federal Reserve cutting rates does influence things like T-bills, which is why those short-term rates have dropped because they are more influenced by the Fed cutting rates. There is more demand for T-bills from financial institutions, and so the government does have the ability to issue more debt at the short end of the curve. They can use that extra borrowing and pay off some of that longer-term debt. The problem is this puts the US government in a pickle over the long-term because they basically are just putting their entire national debt into short-term T-bills that constantly roll over. Every six to 12 months, they're constantly rolling over $30 trillion worth of debt. And if short-term rates ever do go up as a result of that, that's an instant added cost on the entire national debt. So it's a Band-Aid in the short term, dangerous for the government in the long term, but could provide a boost for the economy in the meantime because those 10-year yields going lower would provide stimulus for economic activity, which means that we are likely to get some sort of a return to the playbook from 1942 through 1951 when the Federal Reserve engaged in yield curve control. The Fed and the Treasury worked together to make sure that the Treasury could borrow at that longer-term end of the yield curve at a rate that was lower than the rate of inflation. In other words, a negative real rate. And because this was enforced on the economy, it wasn't something that the free market did to itself. It allowed the government to offload the cost of its debt onto the economy. This was very effective at that time because things like gold ownership were outlawed, Bitcoin didn't exist. It was very difficult for the average person to invest in stocks, and it was considered patriotic to buy things like US Treasury bonds. But the anticipation of policies like this are why we are seeing dramatic rises in things that are harder assets like Bitcoin, and gold, and silver, and stocks, and real estate. And if you'd like to protect yourself from the government trying to steal your purchasing power in order to offload the cost of its own debt, it might be a good idea for you to consider some of these assets as well. If you'd like to hear more insights about things like this, and especially things that I don't talk about on YouTube, I've got a free newsletter. So if you'd like to see me in your inbox every week, go ahead and click on the link in the description below, and I'll see you there. As always, thanks so much for watching. Have a great day.