On Sunday, TS Lombard’s chief US economist Stephen Blitz highlighted an impending seismic shift at the Federal Reserve. As the lines between the Treasury and the Fed blur, the two institutions’ balance sheets are effectively converging, with Treasury Secretary Besant assuming a pivotal role in this new framework—effectively becoming the "shadow Fed chair."
Blitz noted that the Fed’s latest policy signals indicate a resumption of balance sheet expansion, with plans to purchase $40 billion in Treasury bills starting January and scaling up further in February. While officially framed as managing the Treasury General Account (TGA) surge in April and stabilizing money market rates, the move实质上 reflects the Fed’s commitment to backstop Treasury spending, ensuring deposit institutions face no rate volatility.
This shift not only implies the Fed will suppress market fluctuations but also neutralizes market signals warning of excessive government spending. Under this setup, policy coordination will tighten, granting Besant outsized influence. With potential appointees like Kevin Hassett joining the Fed, a "direct reporting line" to the White House via Besant is emerging, enabling Treasury-led financing strategies—such as flooding the short end to suppress borrowing costs.
Blitz warned this cheap-funding strategy risks elevating inflation by 2026. Despite the Fed’s Summary of Economic Projections (SEP) revising down core inflation forecasts, fiscal stimulus and monetary accommodation could reignite inflation dominance within 1–2 years, heralding a "great disruption" for the Fed and banking sector.
**De Facto Treasury-Fed "Merger"** Blitz argues the Fed’s bond-buying upends traditional market discipline. Chair Powell claimed short-term purchases aim to set money market rates via policy—not open-market operations. Yet Blitz interprets this as the Fed guaranteeing Treasury funding sans rate "blockages." Under this mechanism, the Fed’s policy-rate peg nullifies bond markets’ warning function—where rising rates signal overspending. QE long ago fused the two balance sheets.
Despite philosophical opposition from Dallas Fed President Lorie Logan and Governor Michelle Bowman—who advocate restoring short-term market volatility—Blitz believes political realities will override such principles.
**New Power Structure: Besant’s Dominance** Once Kevin Hassett (a potential Fed nominee) is confirmed, Besant will effectively become his "boss," Blitz asserts. A "unitary executive theory" is operationalized, with daily coordination flowing through Besant. Having steered personnel selections, Besant will wield decisive policy clout.
Besant and Trump seek cheap funding—flooding the short end while capping long-term issuance. The Fed’s short-term purchases align with this goal, directly fueling 2026 inflation risks. Blitz dismisses Powell’s new framework rhetoric as moot ahead of May’s leadership transition. Notably, the "Trump discount" suggests FOMC members projecting sub-3.5% rates within 12 months will jump from 11 to 16—signaling internal bias toward lower rates despite market pricing of ~3.10%.
**Economic Outlook: Near-Term Weakness vs. Long-Run Inflation** Blitz reads Powell’s presser as hinting at deeper economic softness than headline data. A 60k downward revision to nonfarm payrolls implies contraction—not growth—triggering Fed rate cuts, as negative job trends historically drive easing.
Ex-tariffs, inflation already runs below 2%. Should data confirm this, markets may price in more cuts or a faster descent to 3.00–3.25%. Yet short-term easing coexists with long-term inflation risks. Blitz concludes that barring weaker-than-expected early-year data, the broader trend is inflationary. Fiscal support will limit downturns, reigniting inflation by late 2026 or 2027, rendering conventional policy forecasts unreliable.
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