Last year I wrote an article arguing that we cannot easily bet that the Fed will cut interest rates soon, but instead we should be wary of the Fed raising interest rates to some extent.

I haven't written any articles about Fed policy speculation since then because the market has been full of optimistic rate cut talk, which is clearly contrary to my view.

However, the changes in market sentiment since then have been very interesting: from the initial optimism that interest rates would be cut soon (some said in December last year, some said in March this year...), to now there is basically no mention of a rate cut in the first half of the year.

As to why market sentiment is so irrational, I once shared my views in a Twitter exchange at the beginning of the month: many articles and opinions on the market discussing interest rate cuts are irrational and emotional, and even lack some basic logic.

I once said that the Federal Reserve's policy is not a "conspiracy" but an "open conspiracy." That is to say, unless a black swan appears, the Federal Reserve will act transparently according to the public rules it has set. Even if it wants to play "tricks," it will do so openly and will not act recklessly without any clue.

What does openness and transparency mean?

That is, he will share his views and ideas publicly. As for whether readers can read the "hidden meaning" from it, it depends on their own abilities.

However, 99.99% of the articles on the market cannot convey the "hidden meaning" at all, so people can only guess and bet.

Today I would like to share with you a high-quality article that interprets the Federal Reserve’s (future) intentions (see the article link at the end of the article).

This article interprets the speech "Some Thoughts on r*: Why Did It Fall and Will It Rise?" given by Christopher J. Waller, a member of the Federal Reserve Board, in Iceland on May 24. The full text is published on the Federal Reserve's official website and anyone can see it.

At present, the US market generally believes that as long as Trump is not negatively affected by the lawsuit, he has a high chance of winning the election at the end of the year. If Trump is elected, the market believes that Waller is likely to take over from Powell as the next chairman of the Federal Reserve.

This speech is Waller's thoughts on the current interest rate policy in the United States, which can help us get a glimpse into the possible direction of the Federal Reserve's future policies.

Before introducing the interpretation of this article, let me share two prerequisite knowledge points with you:

The relationship between Treasury yields, prices, and coupon rates.

The difference in governing philosophies between the Democratic and Republican parties in the United States.

I once wrote an article specifically introducing the relationship between government bond yields, prices and face rates.

In general, the coupon rate of government bonds is fixed. However, once the government bonds are issued and listed, their actual yield has little to do with the coupon rate, but is closely related to the transaction price of the government bonds. The higher the transaction price, the lower the actual yield; the lower the transaction price, the higher the actual yield.

But when the government issues new bonds, the coupon rate of the new bonds is closely related to the actual yield of existing trading bonds. If the actual yield of existing bonds is very high, it is meaningless to set the coupon rate of the new bonds very low, because it is likely that no one will buy them or they will be forced to issue them at a discount.

Therefore, if we expect the newly issued treasury bonds to have a low coupon rate and be issued smoothly, the actual yield of the existing treasury bonds cannot be high. So how to regulate the actual yield of the existing treasury bonds so that it is not too high? A very important market means is to reduce the supply of treasury bonds on the market, drive up their trading prices, and lower their actual yields.

Next, let's look at the differences between the Democratic and Republican parties in their governing philosophies:

The Democratic Party has always advocated a big government, which means that they believe that a big government has enough power to ensure fairness, help the weak, and maintain social stability and healthy development.

The Republican Party’s philosophy is that the government only needs to do basic work such as maintaining order, supervision, legislation, and law enforcement, and leave other matters to the market. Let the market fully unleash its vitality and creativity. The direct consequence of an overly powerful government is that public institutions become too large and the bureaucracy becomes inefficient, which eventually leads to the breeding of corruption and abuse of power, causing the free market to be disrupted and unable to play its self-regulatory function.

The two parties' ideas are reflected in fiscal policy as follows:

The Democratic government needs to set up more institutions, hire more civil servants, manage more things, and intervene in more market operations, all of which require more money. The most direct way to get money is to issue more treasury bonds, that is, to increase the supply of treasury bonds. Its direct consequence is to force the trading price of treasury bonds to fall and the actual yield to rise.

The Republican government, on the contrary, hopes to cut as many unnecessary government agencies as possible, lay off unnecessary civil servants, and reduce unnecessary government intervention. All of this will naturally reduce government spending and make it unnecessary to issue too many Treasury bonds - that is, reduce the supply of Treasury bonds, increase the trading price of Treasury bonds, and reduce the actual yield.

Of course, the above-listed scenarios are all classic scenarios under ideal conditions. The current Democratic and Republican parties in the United States are no longer 100% classic. However, in some basic principles and policy concepts, the two parties still maintain significant differences, and the policies they formulate are also significantly different.

Let’s look at this article’s analysis of Waller’s speech.

In the Federal Reserve’s public statements in recent years, it is often mentioned that the “neutral interest rate” should be controlled at a certain level.

What is the “neutral interest rate”?

Waller uses two metrics: the real yield on 10-year Treasury bonds and U.S. inflation-protected bonds.

This article draws the following conclusions from its analysis of Waller’s speech:

"What Waller really wants to say is that the current neutral interest rate in the United States continues to rise, mainly due to the rampant supply of treasury bonds. This actually explains from another perspective why the Federal Reserve has been reluctant to cut interest rates. In layman's terms, since the neutral interest rate, which is a reasonable standard, is rising, it is unreasonable to lower the policy interest rate now. If you want to reasonably lower the policy interest rate, you must first lower the neutral interest rate, which is a reasonable standard. And the current neutral interest rate is pushed up by the continued excessive issuance of treasury bonds."

"Or to put it more bluntly, what Waller wants to say is: as long as the left-wing Democratic Party is in power, the national debt will be excessively issued, the neutral interest rate will rise, and the Federal Reserve will be reluctant to cut interest rates. Only when the right-wing Republican Party is in power can the national debt be reduced, the neutral interest rate can be lowered, and the Federal Reserve can continue to cut interest rates cleanly and efficiently."

This analysis brings out the "subtext" of Waller's speech.

Does this mean that the Fed will not cut interest rates before this year's election?

My understanding of this point is slightly different from that of this analysis article.

I think not. It simply expresses the true views of the future Fed chairman on interest rates and the measures he would like to take:

In order to cut interest rates cleanly and efficiently, in addition to other policy measures, reducing the supply of government bonds is probably also an operation that is very worth considering.

Then, we can carefully observe whether the US government will move in this direction.