The Fed Can’t Cut Rates Without Breaking the Bond Market

The confluence of stagnant growth, renewed inflation, and a $40 trillion refinancing burden leaves the Fed unable to cut rates without risking a breakdown in the bond market.

Wells Fargo has withdrawn its forecast of two rate cuts this year, citing transient inflation and heightened uncertainty. Bond markets are demanding higher yields and a greater risk premium to hold U.S. debt, reflecting diminished confidence in near-term rate cuts.

Federal Reserve Chair Jerome Powell acknowledged that, after adjusting for overcounting, there has been effectively zero net private-sector job creation over the past six months. Stagnant job growth would normally prompt monetary easing. But the Fed cannot cut rates while inflation risks remain elevated.

The U.S. must refinance $12–15 trillion in debt over the coming years, with more than half coming due in 2026 at interest rates between 4% and 5%, with upside risk. Each one-percentage-point increase in refinancing rates adds hundreds of billions of dollars in annual interest expenses to an already strained fiscal outlook.

Recent U.S. Treasury auctions have shown weak demand, with investors requiring higher yields to absorb supply. At the same time, corporate bond issuance is surging due to AI-related capital expenditures, increasing competition for fixed-income capital.

The Bank of Japan’s policy rate has risen to 0.75%, with markets pricing in a 63% chance of a further 25-basis-point hike on April 28, 2024. Higher Japanese yields are undermining the yen carry trade, which has long supported global liquidity and demand for U.S. assets. A large-scale unwind of the yen carry trade would trigger broad asset selling, including U.S. Treasuries, at a time of already fragile market conditions.