--- title: "The Fed's Hidden Strategy: How Low Interest Rates and Loosening of Banking Controls Can Combat Inflation" type: "News" locale: "en" url: "https://longbridge.com/en/news/293412606.md" description: "The Federal Reserve faces a policy dilemma in 2026, balancing inflation control against high government debt that limits traditional tightening tools. While June CPI dropped to 3.5% due to lower energy prices, core inflation remains sticky. Chairman Kevin Warsh pledges zero tolerance for persistent inflation. However, rising interest costs on $39.5 trillion debt create a vicious cycle, potentially exacerbating inflation through supply chain pressures and credit dynamics, prompting reviews of data collection methods." datetime: "2026-07-22T02:46:03.000Z" locales: - [zh-CN](https://longbridge.com/zh-CN/news/293412606.md) - [en](https://longbridge.com/en/news/293412606.md) - [zh-HK](https://longbridge.com/zh-HK/news/293412606.md) --- # The Fed's Hidden Strategy: How Low Interest Rates and Loosening of Banking Controls Can Combat Inflation The Federal Reserve faces an unprecedented policy dilemma in 2026: on the one hand, it is committed to resolutely curbing inflation; on the other hand, the structure of the US economy and government debt is no longer able to withstand the impact of traditional tightening tools. In June 2026, the US Consumer Price Index (CPI) rose 3.5% year-on-year, a decrease from 4.2% in May, and fell 0.4% month-on-month, the largest monthly drop since 2020, mainly due to a temporary correction in energy prices. However, core inflation remains around 2.6%, and food and housing costs remain high, continuously eroding the purchasing power of ordinary people. The Fed's Hidden Strategy: How Low Interest Rates and Loosening Banking Restrictions Can Solve the Persistent Inflation Problem—A New Paradigm of Monetary Policy and Potential Risk Assessment Against the Background of High Debt. The Fed faces an unprecedented policy dilemma in 2026: on the one hand, it is committed to resolutely curbing inflation; on the other hand, the structure of the US economy and government debt is no longer able to withstand the impact of traditional tightening tools. In June 2026, the US Consumer Price Index (CPI) rose 3.5% year-on-year, a decrease from 4.2% in May, and fell 0.4% month-on-month, the largest monthly drop since 2020, mainly due to a temporary pullback in energy prices. However, core inflation remains around 2.6%, and food and housing costs remain high, continuously eroding the real purchasing power of ordinary people. Federal Reserve Chairman Kevin Warsh stated clearly during his congressional testimony that the committee has "zero tolerance" for persistent high inflation and pledged to make the inflationary surge of the past five years a thing of the past through "policy and institutional reforms." The structural roots of the persistent inflation problem: Over the past five years, U.S. inflation has been significantly higher than the average level of the past few decades, approaching the characteristic range of the 1970s. At that time, the excessive money supply after the dollar abandoned the gold standard led to long-term runaway prices. Currently, although nominal inflation has fluctuated, wage growth has failed to keep pace with price increases, resulting in a shrinking of real income. The price pressure felt by most households is not due to short-term disturbances, but rather the cumulative effect of rigid expenditures such as housing, food, and healthcare. The month-on-month decline in the June 2026 CPI was primarily attributed to a drop in energy prices, following previous high oil prices driven by geopolitical conflicts in the Middle East. The energy index rose 15.7% year-on-year but fell sharply by 5.7% month-on-month. This volatility highlights the instability of monthly data, while annualized indicators still show an upward price trend. Data from Truflation, an independent inflation measurement agency, shows that its calculated US CPI is only around 2.06% year-on-year, significantly lower than the official reading of 3.5%. This agency utilizes real-time big data and modern consumption patterns to provide a perspective different from the traditional basket of the Bureau of Labor Statistics (BLS). The Federal Reserve has established a dedicated task force to review inflation data collection methods. This could provide a data basis for policy adjustments, redefining the "price stability" target through more timely and multi-source indicators. The Dilemma of Interest Rate Tools: The Counterproductive Effect of Interest Rate Hikes Traditional monetary policy theory holds that raising interest rates can suppress demand and reduce inflation. However, this logic faces challenges in highly leveraged economies. The US national debt has exceeded $39.5 trillion, and net interest payments in the first nine months of fiscal year 2026 were significantly higher than the same period of the previous year, with annualized interest costs approaching or exceeding $1 trillion. The 10-year Treasury yield broke out of its long-term consolidation range in 2026, reaching a high of over 4.6%, while the 30-year yield once exceeded 5%. Higher borrowing costs directly increase government interest payments, creating a vicious cycle: to pay higher interest rates, governments either raise taxes or issue more debt, further crowding out private sector resources. At the corporate level, rising debt servicing costs reduce funds available for investment, R&D, and salaries, ultimately transmitting to prices through supply chains and the labor market. Although M2 money supply contracted briefly between 2022 and 2023, it still showed an overall growth trend, even during interest rate hike cycles. Money is mainly created through credit; if interest rate hikes fail to effectively curb credit expansion, they will instead exacerbate inflationary pressures due to rising production costs. The yield curve shows that short-term interest rates have fallen in response to recent inflation data, but medium- and long-term yields have maintained an upward trend, reflecting market concerns about long-term fiscal sustainability. The government can hardly sustain a prolonged high-interest-rate environment. Treasury Secretary Scott Bessant previously emphasized the importance of using the 10-year Treasury bond yield as a benchmark for borrowing costs. The Logic of Low Interest Rates as a Potential Anti-Inflation Tool Against the backdrop of high debt, moderately lowering interest rates could alleviate pressure through multiple channels. First, lower borrowing costs can free up cash flow for households and businesses, which can be used for consumption and investment rather than debt repayment. Second, the government can reduce its interest burden by rolling over short-term debt to lower long-term interest rates. Interest payments already pose a heavy burden on the federal budget by 2026; reducing some of these costs from $1 trillion to a lower level would free up fiscal space. Businesses benefiting from lower financing costs can increase hiring, expand production capacity, and invest in R&D, driving supply-side improvements. Stock markets typically find support in low-interest-rate environments, and the value of the bond portions of pension and 401(k) plans also rises, thus enhancing the household wealth effect. Crucially, new credit must be linked to productive investment and profit incentives, rather than the unconditional transfers of 2020-2021. That round of monetary expansion primarily stemmed from direct checks, leading to a surge in money supply without corresponding productivity gains. A possible coordinated strategy between the Federal Reserve and the Treasury lies in deregulating banks. Currently, banks are constrained by regulations such as the Supplemental Leverage Ratio (SLR), forcing them to hold significant amounts of Treasury bonds and limiting private sector lending. Relaxing these restrictions would allow banks to expand lending to the private sector while simultaneously suppressing long-term yields through Treasury bond purchases. The Trump administration has clearly pushed for “responsible deregulation” of the financial sector to promote private credit growth and economic re-privatization. Reforms are expected to proceed in the second half of 2026, including adjustments to the Basel III final rules and reductions in additional capital requirements for systemically important banks. This will unleash bank lending capacity, push the yield curve down overall, and provide low-cost capital to the real economy. The profit-driven nature of bank lending ensures that new money supply is linked to productivity gains, avoiding unnecessary monetary expansion. The prospects for policy coordination and market impact: By combining new inflation measurement methods, interest rate adjustments, and bank deregulation, the Federal Reserve is expected to stabilize prices without triggering a severe recession. The market may be poised for a boom driven by credit expansion and improved corporate earnings, with equities and risk assets benefiting significantly. However, all booms in history have ultimately been followed by corrections. Debt accumulation, asset bubbles, and potential external shocks (such as geopolitical events or supply chain disruptions) pose systemic risks. The current federal funds rate remains in the 3.50%-3.75% range. Market expectations for short-term rate hikes have cooled due to June inflation data, but long-term yield pressures persist. The Federal Reserve needs to balance its dual mandate of price stability and financial stability, guiding expectations through data-driven communication strategies. While the path of low interest rates combined with regulatory easing is theoretically attractive, its implementation faces challenges. A continuously expanding fiscal deficit and the snowball effect of debt may undermine policy credibility. Excessive concentration of bank lending in specific sectors, or moral hazard arising from deregulation, will amplify financial vulnerabilities. The global environment is also significant: policy divergence among major economies, trade frictions, and the energy transition could all disrupt the US inflation path. Investors should pay attention to the shape of the yield curve, bank credit growth data, and emerging inflation indicators. Diversified asset allocation, a focus on asset-liability matching, and maintaining risk awareness during periods of prosperity will help address potential cyclical turning points. The Fed's "impossible mission" tests not only technical tools but also the comprehensive ability to coordinate policies and maintain fiscal discipline. Only by achieving a balance between supply-side productivity improvement and demand management can the US economy escape the high-debt-high-inflation predicament and achieve sustainable growth. ### Related Stocks - [SPY.US](https://longbridge.com/en/quote/SPY.US.md) ## Related News & Research - [LIVE MARKETS-That's why AI is going to be inflationary in the short-term](https://longbridge.com/en/news/295920154.md) - [Philippine central bank says inflation to ease gradually, risks remain on upside](https://longbridge.com/en/news/296045506.md) - [Why The Fed’s Balancing Act Is Tilting in Wall Street’s Favor](https://longbridge.com/en/news/296028688.md) - [POLL-Fed to hold interest rates this year, economists say, sticking to their view](https://longbridge.com/en/news/296094878.md) - [Why The Fed’s Balancing Act Is Tilting in Wall Street’s Favor](https://longbridge.com/en/news/295842249.md)