The federal government, financial markets and most Americans are all in a state of denial about interest rates. Whenever someone goes on business TV, gets a mortgage or makes a long-term debt projection, I usually hear some variation of the phrase, “when rates go back down.”
I am sorry to be the bearer of bad tidings, but rates are not going back down, especially to the levels of the 2010s. And almost any attempt to try to force them down — what we economists call financial repression — will only bring pain.
With higher debt, global decoupling, a more uncertain inflation outlook and the natural economic cycle, rates are probably going to stay high. That poses a big problem for President Donald Trump and his administration’s plans for the economy. Not only do higher rates make it more expensive for the federal government to borrow, but they also do the same in the private sector, reducing economic growth. Perhaps most worrying for the administration, they keep the cost of housing high.
It’s no wonder that Treasury Secretary Scott Bessent is focused on bringing down the 10-year bond yield — or that the president is so obsessed with getting the Federal Reserve to lower rates. But the Fed does not have much direct control over the natural level of interest rates. They are a function of the market, particularly inflation expectations, the risk outlook for bonds, and the macro economy. And with increasing debt and the possibility of high tariffs, rates will probably rise even further.
Thus far, the Fed is holding firm against cutting rates. So it’s not unreasonable to expect financial repression — that is, “strongly encouraging” investors to buy bonds. Historically that has meant capital controls, which essentially force investors to buy domestic debt. That seems to be off the table at the moment. The more common path to financial repression is through regulation.
A few possibilities are already evident.
One is something called the supplemental leverage ratio. Currently banks must maintain a 3% to 5% ratio of equity to assets (regardless of their risk). Banks argue that, because US Treasury debt is treated like a risky asset, they are limited in how much of it they can buy. This makes the market for US debt less liquid.
The Fed is considering changing the way this ratio is calculated, or lowering it, and there are good arguments for doing this — both from a risk-management perspective for the banks and because it may well make the Treasury market more robust. The timing is also pretty good for the government, because if banks bought more longer-term Treasuries, that would probably mean lower bond yields.
Another possibility for repression is the push to regulate stablecoins — crypto assets that hedge dollar risk. The hope is that regulation will make stablecoins more mainstream. This would have implications for the Treasury market. The value of stablecoins is tied to the value of the dollar — the issuer hedges by buying lots of short-term Treasuries. More demand for stablecoins would bring more demand for Treasuries, which would also lower their yields.
Financial repression, it must be said, does not have a great track record. Keeping rates lower than where the market would set them tends to provoke inflation. Alternatively, the strategy just stops working at some point. Japan, for example, was able to be financially repressive for decades, as its banks and pension funds bought a lot of domestic debt, keeping rates low despite very high government debt levels. But when inflation returned, the Bank of Japan could not hike rates, and the yen depreciated — then rates went up anyway.
That said, the US government’s current plans also pose risks. A smart adjustment to the leverage ratio may be necessary to keep Treasury markets more liquid, but if the goal is simply to lower rates, the change may just feed inflation and debase the dollar. And regulatory changes to crypto, which despite some clever marketing nomenclature is not the most stable asset, could make the system riskier. There is no obvious reason to own stablecoins, for example, unless you think their price will increase or engage in criminal activity. This makes it susceptible to a collapse in demand, which would precipitate a Treasury selloff, which would mean a spike in rates.
Of course, there is one fail-safe method for the government to lower rates: It could show that it has a credible plan to reduce long-term debt by reforming entitlements. That seems highly unlikely, to put it mildly — which explains why we’re talking about financial repression instead.
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