Is monetary policy in the hands of the Fed or the Treasury?

Mabrouk Chetouane, Head of Global Market Strategy at Natixis Investment Managers, and David Rolley, Portfolio Manager and Co-Head of the Global Fixed Income Team at Loomis, Sayles & Company, compare their views on the threat to the Fed’s independence, US growth prospects and the impact of US debt on the bond market. 

Mabrouk Chetouane (MC): Concerns over the US fiscal picture have been a recurring theme for markets in 2025. How can the US slash its public deficit?

David Rolley (DR : There are a couple of ways to fix it. The old-fashioned way is you raise taxes and cut spending, then move to some kind of primary balance. That's what the British did after they ran the deficit up to 200% of GDP to deal with Napoleon. They ran a budget surplus for 80 years on their primary balance. That was with a gold standard and with interest rates between 3% and 4% most of the time, even though real growth was only 2%. The Victorians did hardcore fiscal austerity. They were tough. We are not – we have a different plan, which is to grow out of this.

To do that, the growth rate has to be higher than the real interest rate. And that means that nominal growth has to be higher than nominal interest rates. I think we could see measures to increase the demand for Treasuries through a capital relaxation on our biggest banks. We have supplementary capital requirements and that could likely be relaxed specifically for Treasury holdings. Vice Chairman for Supervision Michelle Bowman has said the Fed intends to review capital requirements.

There's also an intention within the current administration to significantly promote the use of stablecoins, a kind of narrow banking whereby entities take deposits but are restricted from making loans and can only invest in very safe, high-quality, liquid assets, like short-term Treasury bills. And the hope is that will increase the bid for Treasury bills.

MC: So, do you believe that the Fed's independence is under threat?

DR: Well, so far, it’s all carrot. But there's also a stick, which involves fiscal dominance. When a government's spending and taxation decisions determine its country's monetary policy, effectively forcing the central bank to prioritise the government’s goals over its own, you have what macro economists call fiscal dominance.

So yes, I think there is an idea to have a majority of the Board of Governors ultimately be appointed by the White House and be Treasury-friendly. I think there is a desire to push down interest rates, independent of what inflation and unemployment are doing, with a fiscal funding dimension to the policy that is new. That has not been how monetary policy has worked in the United States for a long time. You’d have to go back to World War II and the five years after. The Fed had an understanding with the Treasury, and they pegged the entire yield curve to keep it low. And the Fed imposed that with the willingness of Treasury.

A return to fiscal dominance would probably increase inflation risks in the medium term. You would expect to see lower policy interest rates offset by a steeper yield curve unless you go back to explicit quantitative easing in the form of Federal Reserve purchases of longer-dated paper. We're not there yet, but those are issues the market is weighing.

MC: What would you say is the most pertinent risk for investors?

DR: The inflation risk premium, or rather how investors are being asked to be compensated for inflation risk. Look at the five-year forward inflation expectation. The current data, stable at around 2.5 %, is not showing that there's any kind of a Treasury buyer’s strike. The only sign we saw of a buyer’s strike was actually early in the year when, in reaction to some of the tariff initiatives, you saw forward fed funds decline. But 10-year through 30-year Treasuries increased and we built in a tariff supply-side shock risk premium into longer bonds off about 40 to 50 basis points. That was new, but that is a sign that we're in a different world.

Those term premium spikes are probably going to be more common than they have been in the past. It might have surprised the markets because it was so unusual. That was part of what you might have called about a month-long period where there was a psychology called “Sell America” that you saw in both the stock and bond markets.

But we seem to have kind of emerged from that over the course of the summer and you don't see so much of that right now. But Treasury fiscal dominance is just beginning to emerge as a new potential factor, and I think it could have staying power.

MC: According to data from Treasury International Capital (TIC), some countries that are usually buyers of US bonds have decided o reduce their exposure to US debt. In your opinion, is it a temporary reaction to market volatility or a more structural trend caused by the weakness of the dollar, with a decrease in demand from international investors for US assets?

DR: If you're talking about the US dollar, you can't just talk about the bond market. You have to also talk about the stock market. Equity flows are even bigger than bond flows across the currency boundary. And if you look at how global portfolios have evolved, a lot of big institutional investors outside the United States have bought a lot of US equity, particularly the technology sector.

One of the phrases you used to hear in places like Europe or Australia, where they have big pension funds, is that “There Is No Alternative,” or TINA. You have to own this US equity bucket, otherwise you underperform.

Historically, when you look at the evolution of the US equity market weight versus global equity, the US share has just continued to rise consistently over the past ten years. It's at all-time highs now.

MC: I do agree that there really is no alternative. If you want growth equity, you have to be exposed to the US stock market and more particularly to the technology sector. It still delivers earnings to its shareholders. And the US stock market is a support for the US dollar. But, in my opinion, there is something quite new happening and we are wondering how to think about it in Europe.  In the past, German, Japanese, or French savings funded the US deficit. It did not pose any problem. Now we are in this debate.  These savings could continue to fund the US deficit or not. And what could be the consequences on the bond market? What is your point of view?

DR: I think it's new and it's fundamental. First of all, I think that Europe will in fact be forced to fund a much larger share of its defence. The pattern of European spending is going to change. There will likely be fewer transfer payments and more fundamental defence expenditure, and that's going to be across multiple countries.

We are still in the early stages, but I think that is a structural change, and it is arguably healthy in terms of rebalancing the burdens of European defence. Europe can certainly afford it and it's a big place and they probably need to do it. There is an investment need within Europe that will keep some of that capital home.

So, the question is, what do the Americans do? One of the things that they're hoping for is to increase the demand for dollars from emerging markets through stablecoins, which in effect is a kind of currency substitution.

MC: What do you mean by currency substitution?

DR : Consider yourself in a country that might have some local currency challenges. Wouldn't it be nice if you could invest in a dollar deposit on your cell phone and your cousin who's working in North America could send money home with a click on his phone and it is there?

That is the potential of stablecoin fintech. If you were to bring this capability to people who are not in the United States, people who may not see their local currency as a reliable store of value, then maybe you can increase the demand for dollars worldwide. Of course, new digital forms of capital controls could be a hurdle to widespread adoption. But we are talking about potential structure changes down the road.

MC: Can tariffs help reduce the US deficit?

DR: I don’t think that current tariff rates are going to get doubled again. If you go from 2% to 15%, you raise a lot of money. But if you go from 15% to 30%, you probably make a mess of the economy.

I think there's probably a natural limit to how much money we can collect with tariffs, so I see a renewed focus on spending cuts. For example, reduced spending on things like Medicaid – which provides health insurance for adults and children with limited income and resources – through tougher rules on enrolment. That's all scheduled to come into effect after the midterms, so that's a 2027-2028 fiscal tightening.

There are questions about the US growth rate, whether productivity can accelerate enough to offset the end of labour force growth. US labour supply growth has to come either from organic demographics, which has been trending down, or from net migration, which is likely to be around zero. It could actually be negative for a time given deportations, but a I think zero growth rate on the labour force is a reasonable forecast, and that was one of the things that Jerome Powell talked about in Jackson Hole.

That leaves productivity alone as the source of all your growth, because growth is labour multiplied by productivity. Perhaps AI can do some of the heavy lifting for us? In general, my view is there's still a positive US exceptionalism story around technology, but the base is getting narrower and narrower. There are vulnerabilities across the tech landscape. Some of it's up and to the right, some of it isn't.

The outlook for other potential growth drivers is also muddy. You can look at the cuts in fundamental science research, particularly in the biotech and healthcare area as a negative risk. If the fundamental discovery pipeline is choked or reallocated to Europe, I think that’s a concern. We've also cut way back on energy transition capital expenditure.

In a global portfolio allocation, you have to decide which US growth prospects you can depend on. Maybe you want to be more diversified. Maybe you want to look for other sources of growth around the world that might have maybe more predictive stability. Labour force growth was one of the differentiators between the US and Europe, and now it's not. We'll have to wait and see. So, you've got to learn about a lot of other countries and a lot of other economies. I think it's a research challenge for capital allocators.

Interview conducted in August 2025