The Retired Investor: A Different View on Interest Rates

Scott Bessent, the nation's new Treasury secretary, is a product of the investment world. His private sector background brings to the government a different set of tools and ideas that may lessen the burden on the Federal Reserve Bank in its fight against inflation.

 

For decades, politicians of both parties with few exceptions have left it up to the Federal Reserve Bank to curb inflation while maintaining employment. It has been a tough job, especially when fiscal policy is working at cross purposes with their mandate. The fly in the ointment over the last several decades has been that while the central bank has been largely insulated from political pressures and has functioned independently, the Treasury is not. It answers to the president and through him his political party.

 

Fast forward to today. Most readers know that the government has a big spending problem. At the same time, over the last four years, we have witnessed a rebound in inflation that climbed to as high as 9 percent. Massive spending programs made inflation far worse.

 

The Fed's job was to reduce inflation, so it hiked interest rates while reducing the number of government bonds it purchased. It has been a long fight to quell inflation, and it is not over yet. It would have been easier if Congress and the president were willing to reduce fiscal spending. Nonetheless, the Fed had made enough progress despite the fiscal failure to cut spending, that in September of last year, the central bank was able to cut interest rates for the first time in four years. They reduced the Federal Funds short-term interest rate by 25 basis points.

 

The way it works is the central bank has the power to cut interest rates on securities on the short end of the yield curve like notes, bills, etc. but not on the long end where the yields on the 5-10-20-30-year bonds are determined by the market in general. Normally, when the Fed cuts rates on the short end, bonds of longer-dated maturities fall. This time around that was not the case.

 

The U.S. Ten-Year Treasury bond, and bonds of lengthier maturity, failed to follow short-term bills and bonds. In fact, although the Fed has cut interest rates several times since then, longer-dated securities have risen in price. Why?

 

Government spending remains out of control. The nation's deficit and debt are at record highs. If that situation continues, the bond market will continue to demand higher and higher interest payments to buy Treasury bonds. It appears the Fed can do no more in the face of the prolific spending by our elected officials.

 

Unlike other politicians, Bessent understands the problem. He said last week that "we are not focused on whether the Fed is going to cut." Instead, he wants the Trump administration to reduce the yield on benchmark Ten-Year U.S. Treasury bonds through fiscal actions.

 

He knows that the interest rates Americans pay on mortgages, credit cards, and other kinds of loans are based on the 10-year Treasury yield and not the Fed Funds rate.

 

Instead of leaving it up to the Fed, which is pushing on a string at this point, he wants to cut government spending that is a major source of inflation, debt, and the deficit. He also hopes to sustain economic growth at a 3 percent rate by cutting regulations and boosting energy production by 3 million barrels a day of oil equivalents. That would also raise tax revenues.

 

If he can accomplish that, then the bond market will take care of long-term rates all by themselves. If bondholders see that the deficit and government debt is coming down, then buying and holding long-dated Treasuries will be less risky. To me, it is the first practical plan I have heard to reduce the national debt which has become the nation's number one challenge on the economic front.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.