If you were sitting in Powell’s chair right now, the choices are all bad. Rate cuts with inflation heating back up would be reckless, but blindly hiking or extending QT into a slowing economy risks detonating credit markets. The Fed is boxed in because both sides of the balance sheet are broken: short-term liquidity is fragile while long-term yields are punishing households, government financing, and banks holding duration losses.
The real pressure point is the Treasury market. QT forces private buyers to absorb new issuance, but banks don’t have the capacity without balance sheet relief. That’s why cutting rates or even hinting at QE is read as capitulation. Yet, a targeted QE in long-dated bonds could make sense. It addresses the cost of government borrowing, keeps housing from falling into outright collapse, and signals stability to bondholders without stoking speculative manias fueled by cheap short-term funding.
Short-term yields mostly feed Wall Street trading activity. Long-term yields drive mortgages, corporate loans, and deficits. Bringing down the 10- and 30-year rates does more for real people than shaving 25 bps off Fed funds. But housing affordability is so distorted that even at 3%, a $500,000 home is still far above the middle-class ceiling when factoring in taxes and fees. Lower rates won’t solve the affordability trap, but they can soften the descent rather than trigger an implosion in residential and commercial real estate at the same time inflation re-accelerates.
There’s no clean exit. QE worked better than critics admit in stabilizing systemic crises, but repeating it under stagflationary conditions is like playing with nitroglycerin. The longer the Fed waits, the more binary the outcomes become: either managed decline with targeted balance sheet moves, or a disorderly unraveling of housing, CRE, and bonds all at once. The trade-off is whether to let inflation run hotter temporarily, or risk a credit collapse that leaves policymakers with no functioning levers left.