Fed Faces Challenging Policy Situation Amid Shift in US Debt Growth
The Federal Reserve is facing a challenging policy situation due to changes in the composition of U.S. debt growth. According to TS Lombard, private-sector borrowing accounts for a shrinking share of overall U.S. debt growth, which could weaken the impact of higher interest rates. Economist Steven Blitz points out that slowing the economy through monetary policy would require a more aggressive contraction in private credit growth because the private sector has become less leveraged and its debt is less sensitive to short-term rates.
The shift in debt mix has also changed the relationship between borrowing and inflation. Since 2012, federal debt growth has shown a stronger correlation with inflation than household and nonfinancial business debt. Blitz notes that before 2012, private-sector debt growth was more closely linked to inflation.
Fed Chair Kevin Warsh and Treasury Secretary Scott Bessent may have considered allowing the yield curve to steepen instead of hiking rates. Under this approach, the Fed would hold the funds rate while letting 10-year yields rise to reflect supply and demand for capital. Blitz expects Warsh to find a way through the CPI data and avoid a September hike, allowing the curve to steepen.