Controlling Fed Comes First. What Follows?

Beware of Yield Curve Control!

The White House’s attempted firing of Federal Reserve Governor Lisa Cook—and Dr. Cook’s decision to sue rather than resign—has moved the struggle over Fed independence from innuendo to open confrontation. Cook sued to block the move, calling it “unprecedented and illegal”. A federal judge has begun weighing her request, and major news outlets now expect the case to move quickly through the courts to reach the Supreme Court.

The administration’s stated “cause” centers on old, disputed mortgage fraud allegations. Cook denies them. Irrespective of the legal merits of the case, the market takeaway is simple: This is a bid to tilt monetary policy even before Jerome Powell’s term as Chair ends in May 2026.

What would happen to rates if the President cannot induce Powell to resign immediately but can pressure or entice other Governors to vote against Powell? Remember the voting math. The FOMC has 12 voters when fully staffed — seven governors (permanent) plus the New York Fed president (permanent) and four rotating regional Reserve Bank presidents. A simple majority sets policy. Historically, governors have tended to align with the Chair, but that is convention, not the law. If the White House dangles elevation to Chair as a carrot—and if a governor bloc breaks away from Powell to push for a cut—short-rate expectations will fall even with Powell in the big seat.

In that case, Fed funds futures would quickly price earlier cuts with money-market rates and two-year Treasury yields following. But longer-term yields would likely rise, not fall. Why? Because politicized easing would raise the term premium. Investors will demand compensation for an elevated inflation risk, for a heavier Treasury supply pipeline, and for the prospect that today’s “easy policy” becomes tomorrow’s credibility problem. The result would be a steeper yield curve — lower on the front end but higher on the 10s and 30s—the very configuration I have repeatedly warned about.

That steepening would create a quandary for the administration, which has indicated repeatedly that it wants lower long-term yields to make mortgages cheaper and to reduce US debt service cost. How do you force down the long end after you have spooked it? One answer already being floated in policy circles is Yield Curve Control — administratively capping specific Treasury yields with as much Fed purchases as necessary.

We have done it before. Beginning in 1942, the Fed capped long bond yield at 2.5% to finance World War II, then kept the caps during the Korean War financing strain. It “worked” until it didn’t. Inflation pressure and mounting Fed balance sheet distortions led to the 1951 Treasury-Fed Accord, the peg ended, and long yields surged —handing painful losses to holders who had bought at the lid. The historical rhyme should give today’s officials pause.

There is also a modern case study. The Bank of Japan’s YCC (targeting ~0% on 10-year Japan Government Bonds) repeatedly had to widen its bands and add “flexibility” as market pressures built. Each tweak jolted global rates and exchange rates. Exiting caps— even gradually — proved market-moving and credibility-taxing. An American YCC — layered atop a huge Treasury issuance calendar and a politically charged assault on the Fed — would likely face even bigger “exit” volatility. If caps become the policy, the Fed’s balance sheet must absorb whatever supply the market refuses at the cap. Term premium would be suppressed until it isn’t, and the eventual adjustment for investors would be abrupt and painful.

Bottom line: The surest path to higher mortgage rates and larger long-term US Treasury financing costs is to strong-arm the central bank into making near-term cuts. Markets will see through it. Investors will demand a fatter premium at the long-end due to higher inflation expectations.

If the Administration’s next step is YCC, enjoy the calm while the cap holds—and then remember 1951!

Dr. Komal Sri-Kumar

President, Sri-Kumar Global Strategies, Inc.

Santa Monica, California

www.srikumarglobal.com

@SriKGlobal

August 30, 2025

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