Transcription
When interest rates fall, markets rally; when interest rates rise, markets fall. This is especially true for long-term interest rates, which are mainly determined by yields on long-term government debt.
In case you missed the news, the Trump Administration wants to lower the yields on long-term U.S. Treasuries. If Trump and his team manage to do this, the result could be a massive rally in the markets. That's why today we're going to do a deep dive into how the Trump Administration plans on bringing down long-term interest rates, whether this plan will succeed, and just how much the markets could pump. My name is Nick, and this is a video you do not want to miss.
When you think of U.S. interest rates, you might think of Federal Reserve Chairman Jerome Powell. Since Trump took office, however, all eyes have been on Treasury Secretary Steven Mnuchin, who aims to bring down long-term interest rates with his so-called "3-3-3" plan. But first, a bit of background: the Treasury Department is tasked with managing the U.S. government's spending, including collecting taxes and issuing debt in the form of U.S. bonds. For those unfamiliar, Mnuchin is a hedge fund manager known for working alongside famous investors like George Soros. To be exact, Mnuchin is known for helping George Soros break the Bank of England in the 1990s, wherein they basically crashed the price of the British pound while shorting the currency, making an absolute fortune. So it's safe to say that Mnuchin knows how currency and bond markets work and how to affect them. This ties into Mnuchin's 3-3-3 strategy. In short, it involves getting real GDP growth to 3% per year, lowering annual budget deficits to 3% of GDP, and increasing U.S. oil production by 3 million barrels per day. The fundamental purpose of these policies is to increase the global demand for government bonds.
This is where things get a bit technical, so listen closely. U.S. bond yields are determined by the price of these bonds. Like all assets, the price of U.S. bonds is determined by supply and demand. The higher the price of the bond, the lower the yield; the lower the price of the bond, the higher the yield. To lower bond yields and interest rates by extension, Mnuchin needs to reduce the supply, increase demand, or both. In case you forgot, supply comes from the Treasury, which issues bonds to fund U.S. government spending. The more government spending there is, the more the Treasury needs to issue these bonds—greater supply and assuming the same or less demand means that bond prices fall and yields will rise. This is why Mnuchin wants to cut spending; less spending means less bond issuance and lower bond yields.
As you might have noticed, this cost-cutting has been coming primarily from the Department of Government Efficiency (DOGE), headed by Elon Musk. Again, the goal is to cut enough spending so that there is less bond issuance and lower yields, but we'll come back to that a bit later. This relates to the demand side of the equation, which is where things get interesting. The demand for U.S. bonds can technically come from anywhere, including the Treasury itself. As a fun fact, the Treasury has been doing bond buybacks in the past, and some would argue this was a way of influencing interest rates. As most of you will know, the demand for U.S. bonds has been declining. This is due to a series of factors, including fears of confiscation related to sanctions, as well as concerns about government spending and inflation, which risk lowering the value of the bond in real and inflation-adjusted terms. This is why Mnuchin wants oil production to increase; more oil production means less inflation and more U.S. bond demand.
What's fascinating is that Trump's erratic foreign policy fits hand in glove with Mnuchin's 3-3-3 plan. Trump's efforts to quickly resolve conflicts in the Middle East and Ukraine could reduce geopolitical uncertainty, resulting in more bond buying by foreign investors. At the same time, Trump's comments around Canada and Greenland could be a crude method to secure more natural resources, which, of course, would lower inflation. As for GDP growth, data from the BLS suggests that it's already close to Mnuchin's 3%, hitting 2.8% in 2024. Of course, GDP is another factor that influences bond demand; the higher a country's GDP, the more demand there is for their bonds, assuming things like inflation are in check. The catch is that a lot of this GDP growth has come from government spending, which, you'll remember, is being clawed back. Meanwhile, tariffs could risk raising inflation, while oil companies may not want to pump more because lower prices would mean lower profits. This is where the real rabbit hole begins. But before we go down that rabbit hole, if you're enjoying this video so far, then smash that like button to let us know, and don't forget to subscribe and ping the notification bell as well to make 100% sure you do not miss our next video.
Now, before we dig into whether Mnuchin's 3-3-3 plan will succeed in lowering interest rates, we need to address the elephant in the room: Jerome Powell. Whereas long-term interest rates are determined by bond yields, the Fed's policy determines short-term interest rates. The caveat is that the Fed can influence long-term interest rates by buying U.S. bonds in a process known as quantitative easing (QE). To refresh your memory, long-term interest rates are determined by bond yields, which are determined by bond prices, which are determined by supply and demand. According to data from Visual Capitalist, the Fed has bought roughly 15% of the government's debt. As you've probably heard, the Fed has been slowly reducing its holdings of U.S. bonds in a process known as quantitative tightening (QT). What you may not know, though, is that QT does not involve selling U.S. bonds; rather, it involves allowing U.S. bonds to mature and then refusing to buy additional bonds. As such, the Fed's QT has resulted in a decline in demand rather than an increase in supply. This demand has been declining at a rate of $25 billion per month. It might not sound like much, but it's enough to move the needle around the margins. As you've probably heard, however, the minutes—a.k.a., summary—of the Fed's most recent meeting revealed that it's considering slowing down or even stopping QT. In practical terms, this means that the Fed would continue buying bonds rather than continue buying gradually fewer bonds. This would result in more demand for bonds, raising the price, lowering the yield, and lowering interest rates by extension.
This is where things get a bit technical again, so listen closely. The reason why the Fed is considering slowing down or stopping QT is because of the debt ceiling, or more accurately, the effects of the debt ceiling. As the term suggests, hitting the debt ceiling means that the U.S. government can't fund any additional spending. In case you didn't know, the U.S. government hit that ceiling in late January this year. In theory, this means that the U.S. government cannot spend any more money. In practice, though, it still has money in the Treasury General Account (TGA), which can be simply understood as the U.S. government's bank account at the Fed. The TGA currently has around $800 billion, and the U.S. government can continue operating by spending this money until the debt ceiling is raised by Congress. From the Fed's perspective, the problem is what happens when the TGA needs to be refilled. Obviously, refilling the TGA would involve issuing bonds, but it begs the question of who will buy the bonds. The last time the debt ceiling was raised, the answer was investors who had money at the Fed's overnight reverse repurchase facility, which can be simply understood as a place where investors can keep cash at the Fed. For context, the last time the debt ceiling was raised was in June 2023, and as you can see, the amount of money in the Fed's overnight reverse repurchase facility fell off a cliff as investors rotated out of the special facility and into U.S. bonds being issued by the Treasury. But as you can see, it's now empty. This means that the money to buy the bonds when the debt ceiling is raised will have to come from elsewhere. According to Joseph Wang, a former bond trader at the Fed, this money would have to come from the bank reserves, which can be simply understood as a place where banks keep money at the Fed. In other words, banks would be the primary buyers of U.S. bonds when the debt ceiling is raised. Banks would use their bank reserves at the Fed to buy these bonds. But if the term didn't make it clear enough, the purpose of bank reserves is to ensure that banks have enough money on hand for their day-to-day operations. If bank reserves fall too low, then it could create systemic risk for the financial system. This pertains to a technical term you may have heard about, which is the lowest comfortable level of reserves. The lowest comfortable level of reserves is the lowest that bank reserves at the Fed can go before there's a risk to the financial system. Joseph estimates that this level is around 8% of GDP. With U.S. GDP at around $30 trillion, 8% works out to around $2.4 trillion. The chances are that the Fed wants reserves to be slightly above that level. For reference, the Fed's latest reserve report notes that there are around $3.3 trillion of bank reserves. This means that banks can only spend a few hundred billion dollars on U.S. bonds before draining down their balances at the Fed to a critical level. By reducing or stopping QT, the Fed can effectively share some of the burden of buying U.S. bonds and minimize the amount of bank reserves this will drain.
So why does all of this matter? Because it turns the debt ceiling into a sort of timer for how long Mnuchin and the Trump Administration have to optimize the supply-demand equation for bonds to ensure that yields and interest rates don't rise. This brings us back to Mnuchin's 3-3-3 plan. To quickly recap, the plan involves keeping real GDP growth around 3%, lowering annual budget deficits to 3% of GDP, and increasing oil production by 3 million barrels per day. Again, the purpose of these policies is ultimately to increase the demand for U.S. bonds. That's because it will cause U.S. bond prices to rise, yields to fall, and long-term interest rates to fall by extension. Of the three policies, keeping real GDP around 3% will be the easiest to achieve. That's because the Trump Administration is rapidly cutting regulations, which should increase economic growth. The Trump Administration has also been trying to secure large amounts of foreign investments, with at least $600 billion of investment expected from Saudi Arabia. This will also increase economic growth. The only real threat to GDP is the fact that a lot of this has to come from government spending, which is also being cut back. The thing is that most of the employees being laid off have been given buyout offers, meaning that they will continue receiving income even after they've been fired—apparently for seven months. More than 75,000 federal employees have reportedly accepted these buyout offers. This is extremely important for two reasons. The first is that this could create a scenario where employees who take the buyout offer are periodically earning two incomes: one income from the buyout offer and another income from wherever they find work in the interim. The result is that you will have tens, possibly even hundreds of thousands of Americans who have doubled their spending power. This is where the second thing comes in: 70% of U.S. GDP is consumption, and it goes without saying that people with two income streams will consume more. This will boost GDP. Not only that, but a recent analysis by Moody's found that the top 10% of earners account for nearly half of consumer spending in the U.S. This top 10% of income earners work for and invest in the kinds of companies that will benefit the most from things like cuts to regulations and foreign investment increases. This, of course, means that they're likely to benefit the most because of the Trump administration's GDP boost in activity.
Lowering annual budget deficits to 3% of GDP will be much harder. To put things into perspective, the annual budget deficit is currently around 6.3% of GDP. In raw numbers, that's almost $2 trillion per year. Differently put, the U.S. government is spending $2 trillion more than it brings in in cash each year, resulting in it having to issue over $2 trillion of bonds, which, of course, increases supply, lowering prices and raising yields, etc., etc. Lowering annual budget deficits to 3% of GDP, therefore, requires reducing government spending by more than $1 trillion. Ideally, this will be done before the debt ceiling is raised. That's because if U.S. government spending isn't cut by then, then there will be too many bonds being issued relative to the available demand, forcing the Fed to step in, undermining the U.S. long-term. When you realize this, you understand why the Trump Administration has been doing everything it can to cut government spending as quickly as possible. Trump has been signing executive orders to cut spending to various initiatives, and DOGE has been finding fraud and inefficiencies to cut and reduce costs. Recently appointed Defense Secretary Mark Esper has also ordered the Pentagon to reduce spending by tens of billions. And yet, when you add it all up, it's just a drop in the bucket. DOGE has reportedly cut $55 billion in spending so far, and Elon revealed in an interview that a lot of that was just DOGE making sure that the spending cuts related to Trump's executive orders are being followed. Esper's order to the Pentagon also just totals $50 billion, which pales in comparison to the total defense spending of around $850 billion. On that note, there's been lots of fake news about the Trump Administration wanting to cut back on Medicaid and Medicare, when Trump has specified in interviews that the goal is to reduce fraud. The problem is that this also wouldn't be enough. A recent report by the Government Accountability Office found that there's only about $233 to $521 billion being lost to fraud in the entire U.S. government. I'll remind you that the Trump Administration needs to reduce spending and cut costs by over $1 trillion. Even if DOGE manages to find every instance of fraud and inefficiency, it still wouldn't be enough. This is precisely why investors like Kevin O'Leary are publicly calling for Elon to do more and why even Trump is starting to put pressure on Elon to cut costs faster. Remember, the clock is ticking.
Speaking of which, you'll recall that Trump's erratic foreign policy fits hand in glove with Mnuchin's 3-3-3 plan. In this case, consider Trump's comments about wanting the U.S., China, and Russia to all cut their military spending in half in an agreement to calm things down, so to speak. This is clearly a means of trying to justify cutting U.S. defense spending, which, I'll reiterate, amounts to a staggering $850 billion. Domestically, Trump has reportedly considered signing an executive order to abolish the Department of Education. When you consider that the Department of Education spent almost $270 billion in 2024, it's evident that this would primarily be for cost-cutting reasons. Trump has stated in interviews that he believes states could pay for education themselves, and this would lower federal spending.
This brings me to another elephant in the room: Trump tariffs. In case it wasn't clear enough, the purpose of Trump's tariffs is to raise as much money as possible by practically taxing other countries. Naturally, this has led to concerns that these tariffs could cause inflation to rise in the U.S. In turn, this could lead to a selloff in bonds as investors demand higher yields to compensate for this inflation. History suggests that these tariffs could actually have the opposite effect—deflation—and this is what happened when Trump last levied tariffs in 2019. It's something that was highlighted in Fed transcripts at the time. Oddly enough, these transcripts were released on the same day as the Fed's most recent meeting. Oddities aside, more recent history suggests that Trump's tariffs have mainly been a negotiating tactic. This is evidenced in Trump's initial tariff threats against Canada and Mexico, which were retracted after both countries made concessions around things like border security. However, there have been other tariffs that seem to be non-negotiable, such as the 10% tariffs on all products imported from China. More recently, Trump indicated that the tariffs on Canada and Mexico would actually be going ahead as planned. This is where things get more nuanced and where there's a lot of debate. It's assumed that these 10% tariffs would result in inflation, but it's possible that China could choose to devalue its currency to maintain its export dominance. Alternatively, China could begin exporting from neighboring countries to eliminate these tariffs, or the companies importing these products could also choose to swallow some of the costs. It's even possible that this inflation already happened since many companies began buying extra Chinese products in anticipation of these tariffs. It's also possible that these tariffs are not as big as these companies anticipated, which would mean that they bought more than they actually needed. The result could be paradoxical: a decline in costs because of excess supply of these goods. But what about retaliatory tariffs, I hear you ask? This is where things get truly nuanced. It's believed that retaliatory tariffs could be the true cause of this inflation; however, some macro analysts like Andreas Steno Larsen believe the opposite. Most countries actually have higher tariffs on the U.S. than the U.S. has on them, and these countries cannot afford to escalate tariffs much further. The result could be another paradox: countries keeping their tariffs the same or even lowering them against the U.S. in fears that a trade war would do more damage to their already weak economies. China is evidence of this; its retaliatory tariffs against the U.S. were largely symbolic, according to multiple reports. This makes sense given that the Chinese economy is struggling; it can't afford a trade war.
It's also easy to forget another factor that's similar to tariffs: sanctions. Some of you might recall that the Biden administration had temporarily lifted sanctions on Venezuela, which happens to be one of the world's largest oil producers. Now, the Trump Administration is reportedly considering lifting sanctions on Russia as part of a peace deal in Ukraine. Russia also happens to be a large oil producer. You don't need to be a geopolitical expert to understand why the U.S. is trying to get more oil from other countries—presumably because domestic producers are unlikely to pump more unless oil prices are higher, and the Trump administration doesn't want higher oil prices; it wants them lower to lower inflation. While Mnuchin's 3-3-3 plan specifies that the third policy is to increase domestic oil production, importing large amounts of dirt-cheap oil from countries like Russia has the same effect: lowering the cost of energy, which will lower inflation across the board. If all else fails, the Trump Administration would tap the Strategic Petroleum Reserve, the same way that Biden did, but that would just kick the can down the road. In any case, the key takeaway is that Mnuchin's third policy of increasing domestic oil production by 3 million barrels per day will likely not be done domestically, if only because it would require an almost 20% increase in production per the U.S. Energy Information Administration. To meet this policy goal, the Trump Administration will need to cut corners and cut some questionable deals, and that's exactly what's happening.
This brings me to the two big questions: whether Mnuchin's 3-3-3 plan will succeed in bringing down long-term interest rates, and what this means for the markets. The answer seems to be dependent on what happens with the debt ceiling. I'll repeat that: the ongoing TGA drawdown is likely acting as a de facto timer. Raising the debt ceiling will require Congress to agree on a spending bill. As always, it doesn't look like this is going to happen anytime soon. In short, the Trump administration wants to pass all its main policies in “one big beautiful bill” that will be tabled by the House. By the time you see this video, House Speaker Mike Johnson previously noted that they're aiming to have this one big beautiful bill approved by Memorial Day, which is May 26th. Well, this seems unlikely to happen, and that's because Republicans only hold a small majority in the House and the Senate. More importantly, there are 31 Republicans in the House and 31 Republicans in the Senate who are part of the so-called Freedom Caucus. If the name didn't give it away, the Freedom Caucus is a group of conservative politicians who believe that government spending should be minimized. But by now you'll already know that this isn't really possible. The result could be a few members of the Freedom Caucus voting against the big beautiful bill, along with the Democrats, who are likely to vote against it for reasons that I probably don't need to explain. The fact that House Republicans are considering passing a separate bill specifically around spending cuts to satisfy these fiscal hawks underscores the likelihood that they could try and block this big beautiful bill. This could result in a debt ceiling debate that drags on for a long time, possibly much longer than last time. The last time the debt ceiling was hit was late January 2023, and the debate around it lasted until the very last minute in early June 2023 when a spending bill was passed in the final hour. As you might have guessed, the timing of this final hour was the drawdown of the TGA, which was close to zero. This time around, the TGA drain is starting from a much higher level. Moreover, the runway of the TGA will be extended further by larger tax revenues that are likely to come in around April and May. The result could be a debt ceiling debate that lasts as late as August or even September, which would be crazy. And yet, this is probably what the Trump Administration wants, and that's just because the longer the debt ceiling debate goes on, the fewer bonds will be issued, and the more time that Mnuchin and Co. have to finalize the 3-3-3 plan and find more buyers for these bonds. The Fed would also be more likely to stop QT, which would be stimulative to the markets and the economy, helping with the GDP side of the 3-3-3 plan. Regardless, the fact of the matter is that the ongoing implementation of the 3-3-3 plan could be bullish for the markets, just because of the effects this will have on the supply and demand for bonds. There will be less supply from the Treasury due to the debt ceiling, more demand from the Fed due to the reduction or cessation of QT, and possibly more demand from domestic and foreign investors. As we've learned, this restriction in supply and the increase in demand would cause bond prices to rise, lowering their yields and lowering long-term interest rates by extension. The most bullish scenario for the markets would be for the plan to succeed before the debt ceiling is raised again. That's just because once the debt ceiling is raised, the Fed goes back to QT, and this would be bearish for the market. The same is true if the debt ceiling was raised before the plan succeeded, as it would result in a greater supply of bonds relative to the demand, raising yields and so on—also bearish. The most bearish scenario for the markets, though, would be if the debt ceiling doesn't get raised before the TGA is completely drawn down. This could cause the U.S. government to default, and that would have devastating consequences for, well, everything. You can learn more about that using the link down below. Now, if you enjoyed that video, be sure to check out our latest one right over here, and if you're not subscribed to the channel yet, you can do that right over here. That's me for now. Thank you for watching, and I'll see you next time.