The Federal Reserve has various tools at its disposal to control U.S. monetary policy. The most impactful and visible of these is a change to the federal funds rate — the overnight bank lending rate that serves as a benchmark for other interest rates and has a broad ripple effect on economic activity.
While the Fed elected to hold rates steady at its May 7 policy meeting — a decision that was widely expected — it has since made some under-the-radar moves that have raised eyebrows in financial circles.
The Fed recently purchased $43.6 billion in U.S. Treasury bonds, including $8.8 billion in 30-year Treasurys on May 8, according to a MarketWatch commentary by Charlie Garcia, founder of a peer-to-peer organization for individuals with a net worth exceeding $100 million. According to Garcia, the Fed’s actions amount to a form of quantitative easing (QE), which is when the Fed purchases securities in the open market to increase the money supply and boost economic activity.
“It’s stealth easing,” Garcia wrote. “It’s monetary policy on tiptoes.”
The MarketWatch commentary acknowledged that not everyone agrees that the Fed is engaging in “stealth QE.” Financial analyst Lyn Alden maintained in a May 7 post on X that the Fed is “not doing QE. They’re just doing less QT (quantitative tightening). As their bond holdings mature, they reinvest most of them to avoid having the balance sheet go down quickly.”
At its March monetary policy meeting, the Fed announced that it had begun slowing its rate of QT by easing the pace of Treasury runoff from its balance sheet. The opposite of QE, quantitative tightening is when the Fed sells bonds on the open market to curb inflation by reducing the money supply in the economy.
The significant increase in Treasury holdings amounts to a reversal of that QT policy, according to Garcia, which could be seen as an indication that the Fed is attempting to stimulate the economy without taking the more drastic step of an interest rate cut.
Whipsaw in Treasury yields
Bond yields have an inverse relationship with bond prices. As bond prices rise, yields fall, and vice versa.
During periods of quantitative easing, when the Fed purchases Treasurys on the open market, it increases demand and prices for those securities, which in turn drives yields down.
As bond yields go, mortgage rates generally follow. The 30-year mortgage is benchmarked to the 10-year Treasury rate and is calculated by adding a spread to the 10-year rate. Thus, QE — stealth or otherwise — generally has the effect of lowering mortgage rates over the long term.
Treasury yields have had a wild ride over the past week. On May 12, yields surged amid a bond sell-off as investors scooped up equities following the announcement that the U.S. and China had reduced tariffs on each other’s imports by 115% apiece for the next 90 days as they attempt to negotiate a trade deal. The bond market stabilized by the end of the week following mixed economic reports, including a lower-than-expected inflation report and the second-lowest consumer sentiment index reading on record.
Then came the Moody’s jolt.
Moody’s downgrades U.S. debt rating
On Friday, after the market closed, Moody’s Ratings — one of the “Big Three” credit rating agencies — announced that it had downgraded the U.S. government’s long-term issuer and senior unsecured debt ratings one notch to Aa1 from its highest Aaa rating.
In making the determination, Moody’s noted that “successive U.S. administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs.”
“Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat,” Moody’s wrote in the rating action. “In turn, persistent, large fiscal deficits will drive the government’s debt and interest burden higher. The U.S.’s fiscal performance is likely to deteriorate relative to its own past and compared to other highly rated sovereigns.”
Treasury yields spiked Monday as markets absorbed the news of the Moody’s downgrade. The 10-year yield breached 4.5% during Monday trading and the 30-year yield reached as high as 5.03%, its highest mark since October 2023.
‘Stagflation’ risks and what comes next
During the press conference following the Federal Reserve’s May 7 policy meeting, Fed Chair Jerome Powell stressed that the central bank is taking a wait-and-see approach as it assesses the effects of the Trump administration’s global tariff policies — and how those policies impact the Fed’s dual mandate of maintaining stable prices and maximum employment.
“We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension,” Powell stated. “If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close. For the time being, we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.”
On Monday, JPMorgan Chase CEO Jamie Dimon said during the bank’s annual investor day meeting that he thinks markets aren’t properly pricing in the possibility of higher inflation, according to CNBC. The S&P 500 index has rallied since falling 4.8% the day after President Donald Trump announced his “Liberation Day” tariff policies on April 2. It has now recovered all its losses and is up 10.5% since April 3.
Dimon added Monday that he believes the risks of “stagflation” are roughly double what the market thinks, per the CNBC report.
Stagflation is a combination of stagnant economic growth, high inflation and elevated unemployment. Should that occur, the Fed may effectively find itself with its hands tied, with no choice but to hold interest rates steady. In that worst-case scenario, if the Fed cuts rates, it risks exacerbating inflation; if it raises rates, it could lead to a further spike in unemployment.
If Dimon’s dire warnings become reality, the Fed’s behind-the-scenes dealings will be even more closely scrutinized, with a stealthy quantitative approach perhaps its only recourse.
