Possible options of the Fed:
The Fed's actions remain the most critical variable for global financial markets $NASDAQ Composite Index(.IXIC.US)
1 Setting the Stage: why the triangle looks “impossible”
| Policy lever | Desirable outcome | Undesirable side‑effect |
|---|---|---|
| A. Tariff escalation | Increase fiscal revenue, suppress China's high-end supply chain | Push up imported inflation (already evident; see Reuters report) |
| B. High interest rates | Suppress inflation, support the USD | Lock federal net interest at > 1 trillion $/year (CBO baseline) |
| C. Deficit reduction | Stabilize debt-to-GDP ratio | Politically unfeasible; no consensus on government shutdown or tax hikes |
| D. Debt monetization | Reduce nominal interest burden | Contradicts Fed's 2 % target, undermining USD credibility |
Over the past 50 years, the U.S. typically pressed only two buttons at a time:
1980 s (Volcker + Reagan): A ↓, B ↑, C ↓, D ↓ → Ended stagflation but debt surged
2010 s (QE + Obama): B ↓, C ↓, D ↑ → Stable debt, USD unscathed, mild inflation
The challenge for 2025: A and B move in tandem, creating “top-push” (cost) + “bottom-support” (demand) pressure on inflation, while C and D face political/institutional constraints.
2 Core Constraints
2.1 Fiscal-Political
Divided Congress + 60-vote threshold: Major tax hikes or spending cuts unlikely to pass.
Treasury market depth: Global USD reserves still >58 % (IMF COFER), endogenous demand favors “buying time.”
2.2 Fed Operational
Target remains 2 % CPI (BLS latest YoY 2.4 %).
H.4.1 assets at 6.73 T, QT runway ≈0.3-0.5 T (see prior analysis).
Toolkit:
IOER/ON RRP spread to floor rates
SRF & FIMA repo for targeted liquidity
Reinvestment cap as YCC-lite: From March, Treasury rolloff capped at 5 B/month (FOMC Minutes) — softening QT.
3 Four Feasible Paths
| Path | Logic | Trade-offs | Probability * |
|---|---|---|---|
| ① Prioritize USD & inflation Sustain high rates + mild tariffs | Maintain global reserve currency credibility; Fed holds 2 %; fiscal relies on market absorption | Slower growth, chronic high fiscal interest | 45 % |
| ② Prioritize growth & fiscal Early cuts + slower QT | Reduce interest burden; boost investment | Inflation rebounds to >3 %, weaker USD | 25 % |
| ③ Prioritize inflation & fiscal Tax hikes/spending cuts + high rates | Rapid deficit reduction | Politically unviable (election cycle) | 10 % |
| ④ Prioritize USD & growth Quasi-YCC + fiscal expansion | Flatten yield curve; debt rollover | Fed mandate diluted; inflation risks | 20 % |
* Subjective odds based on 2025 Q1 policy signals, congressional seats, and Treasury market behavior.
4
Path ① is most likely
— “A stronger coin, even at slower speed”
4.1 Mechanics
Hold fed funds at 5.25-5.50 % for 2-3 more quarters → Time-for-space to counter tariff-driven inflation (dubbed “cruel-to-be-kind” by Fed officials).
“Micro-QT”:
Treasury rolloff capped at 5 B/month; MBS runoff undershoots 35 B roadmap.
Expect QT pause by 2025 Q4, total assets stabilize at 6.4-6.5 T.
Treasury ups 7-20Y issuance: Lift avg maturity to 73 months to smooth peaks.
Tariffs as “tactical tool”: Target EV/clean energy, 2025 revenue impact ≈350-400 billion $ (< 0.6 % of total), more political signal than fiscal gain.
“Friend-shoring” subsidies (IRA 2.0): Balance budgets and trade wars.
4.2 Sacrifices
Real growth: 2025 GDP revised down 0.4-0.6 pct from CBO’s 2.2 %.
Labor market: Unemployment rises to 4.4-4.6 %.
Credit: HY spreads widen 80-100 bp; small banks face CRE stress—Fed prefers one-off “bail-in” over systemic recapitalization.
Debt burden: Net interest/GDP hits 3.5 % by 2026-27, but debt/GDP slows until 2028 (110 %).
5 Global Spillovers
5.1 Phase 1: USD strength + capital suction
Yield gap: ECB 2.75 % vs Fed 5.4 %, DXY holds 105-110.
Flows into USTs & tech; EM (high-debt) forced to hike, currency stress returns.
5.2 Phase 2: Supply chain & cost push
China-US-Mexico “triangle”: Tariffs shift final assembly to Mexico, but key parts stay China-made, exporting price pressures.
Global CPI +0.2-0.4 pct (WTO estimate; doubles if decoupling deepens), delaying cuts outside Japan.
5.3 Phase 3: Fragility window (2026-2027)
When Fed cuts but ECB/BoE/BoC lag—
USD catch-down: Flows to high-yield non-USD.
UST bull steepening: 10Y yields drop 100-120 bp, but real debt burden eases slowly.
Risk appetite: Growth stocks & gold lead; commodities diverge (energy/grains weak, copper/REEs strong).
6 Bottom Line: What is kept, what is sacrificed?
| Kept | Sacrificed |
|---|---|
| USD hegemony: Hold 2 % target + yield premium, preserving UST demand; remains global safe haven. | Growth narrative: Accept 0.5-1 pct lower GDP; softer labor market. |
| Inflation anchor: Use rates to offset tariff shocks, CPI 2-3 %. | Fiscal discipline: Net interest >1T, debt/GDP still climbing. |
| Fed independence: Slow QT but retain balance sheet flexibility. | Trade openness: Tech tariffs permanent; deglobalization as “acceptable cost.” |
Global implications
FX: Strong USD → EM outflows, forced hikes.
Supply chains: Migration + tariffs lift global prices.
Assets: Polarized US equities—AI/platforms enjoy “duration premium”; cyclicals squeezed.
Geofinance: Accelerated non-USD trade/gold reserves, but no near-term alternative to USD.
Conclusion: In the “inflation-USD-debt” trilemma, the U.S. likely prioritizes USD and inflation, using growth and fiscal health as bargaining chips. This path avoids a near-term USD crisis but bequeaths higher debt and trade fragmentation to post-2027 policymakers.
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