Madison Investments recently released a strategic judgment that has thrown a shockwave beneath the calm facade of the financial markets. The institution clearly stated: "The Federal Reserve may need to maintain the current interest rate level until the second quarter of 2026." The reason this assertion has triggered deep anxiety in the market is not due to the length of its prediction itself, but rather due to the fundamental shift in the logic of monetary policy it reveals—this is not the traditional "pause in rate cuts" or "hawkish wait-and-see" stance, but rather a near "rate freeze" state: long-term freezing at high levels, holding steady, and actively losing policy flexibility.
When a core economy's benchmark interest rate is maintained at a restrictive level for more than two and a half years, its significance transcends a simple extension of the monetary tightening cycle. It indicates that the asset pricing benchmarks, risk premium models, and cross-asset correlation systems of the entire financial market will face a systemic reassessment. Compared to cyclical adjustments of rate hikes or cuts, the risks implied by this "policy stagnation" state are more insidious yet also more destructive. However, what is truly concerning is not the conclusion itself but the underlying logic driving that conclusion: the Federal Reserve did not actively choose this path but was forced to accept a suboptimal solution under the structural pressures of bonds, markets, and politics. This article will delve deeply into the mechanisms of this policy stalemate, technical representations, systemic risk transmission paths, and their strategic implications for global asset allocation.
1. The limitations of monetary policy tools are highlighted and the expectation of "interest rate lock-in" is formed.
Saunders, the chief economist of Madison Investment Company, put forth a core proposition that is largely overlooked by the market: "The impact of monetary policy on the market is significantly limited." The essence of this statement is a fundamental questioning of the effectiveness of traditional monetary policy. In the past forty years of managing inflation cycles, both the market and policymakers have become accustomed to viewing interest rate tools as the universal key to adjusting the economic cycle — high inflation leads to rate hikes to suppress it, while a weak economy calls for rate cuts to stimulate it. However, the challenges faced by the current U.S. economy are not merely cyclical overheating but deep structural distortions.
Specifically, this limitation is reflected in four mutually reinforcing dimensions:
First, the uncontrollable expansion of the fiscal deficit. The latest data from the Congressional Budget Office (CBO) shows that the federal fiscal deficit for FY2024 is expected to reach 6.8% of GDP, far exceeding the historical average. More critically, this deficit expansion is not a temporary measure during wartime or crises but reflects structural imbalances in a fully employed economy. When the expansionary effect of fiscal policy continuously offsets the tightening effects of monetary policy, the suppressive effect of interest rate tools on total demand is significantly weakened. The demand contraction brought about by each 1 percentage point increase in interest rates by the Federal Reserve may be easily offset by incremental spending stimulated by fiscal measures.
Second, the failure of long-term inflation expectations to anchor. Although short-term inflation data has receded due to base effects, long-term inflation expectations have never stabilized back to the 2% policy target range. Surveys by the New York Fed show that the median three-year inflation expectation remains above 3%. This stickiness reflects the market's fundamental skepticism about the U.S. disinflation process — when factors such as supply chain restructuring, energy transition, and structural tensions in the labor market persist, simply relying on demand management is insufficient to address cost-push inflation.
The third major risk: The non-linear deterioration of the labor market. The superficially low unemployment rate masks deep-seated issues such as the continued low labor force participation rate, structural imbalances in job vacancies, and sluggish real wage growth. The flattening of the Phillips curve means that the trade-off space between monetary policy in curbing inflation and protecting employment has been extremely compressed. Any adjustment of interest rates may simultaneously trigger two adverse scenarios: raising rates rapidly cools the job market, while lowering rates risks an uncontrollable rebound in inflation expectations.
Fourth, the oversupply of U.S. Treasuries and the distortion of term premiums. To fill the fiscal gap, the U.S. Treasury has had to continue to expand the scale of bond issuance, especially with a surge in the supply of long-term bonds. Against the backdrop of major overseas central banks (such as the People's Bank of China, the Bank of Japan) reducing their holdings of U.S. Treasuries and domestic banks experiencing decreased purchasing power due to deposit outflows, the demand elasticity for long-term Treasuries has significantly weakened. This directly leads to a break in the key link of the monetary policy transmission mechanism — while the Federal Reserve can precisely control the federal funds rate (short end), its influence on the interest rates of 10 years and above (long end) has sharply diminished. The "stickiness" of long-term rates is essentially the market's pricing of the risks to the long-term fiscal sustainability of the U.S., rather than just monetary policy expectations.
It is precisely the accumulation of the above structural problems that has led the market to reassess the Federal Reserve's policy space. Each adjustment of interest rates is no longer a simple management of the economic cycle, but a balance on the edge of a knife — the more it moves, the more likely it is to exacerbate contradictions; remaining still is the most prudent "active defense." This is the fundamental reason why the expectation of "interest rate lock-in" has rapidly fermented.
2. The "steepening" phenomenon of the yield curve: Technical evidence of the diminishing effectiveness of monetary policy.
Under traditional monetary policy frameworks, the initiation of a rate-cutting cycle should be accompanied by an overall downward shift of the yield curve and a flattening of its shape — short-end rates quickly drop due to the reduction of policy rates, while long-end rates, although decreasing by a smaller margin, move in the same direction. However, the current market presents an abnormal phenomenon: while short-end rates recede with the expectation of rate cuts, long-end rates not only do not decrease but have recently shown a significant rebound, leading to a chaotic pattern of "bull steepening" and "bear steepening" alternating in the yield curve.
Behind this technical form is the concentrated outbreak of three deep-seated contradictions:
First, the self-fulfilling nature of structural inflation expectations. Market participants are keenly aware that the current inflation pressures cannot be cured merely by total demand management. From the cost rigidity brought about by nearshoring supply chains to the massive capital expenditures required for green transitions, and the resource allocation efficiency decline caused by geopolitical fragmentation, these factors all support long-term inflation. Therefore, even if the Federal Reserve cuts rates in the short term, the market will not correct its long-term inflation expectations; rather, it may exacerbate concerns of being "behind the curve" due to the premature easing of monetary policy, pushing up term premiums.
Secondly, the continued pressure of fiscal irresponsibility on long-term rates. In the absence of signs of convergence in the U.S. fiscal deficit, rate cuts will lower debt interest costs, theoretically incentivizing further fiscal expansion. The market rationally anticipates this, thereby demanding higher term premiums to compensate for future debt monetization risks. In this scenario of "fiscal dominance," monetary policy essentially loses its independence, and long-term rates become an implicit constraint mechanism of fiscal discipline.
Third, the implicit downgrade of long-term credit ratings. Although rating agencies have not formally downgraded the U.S. sovereign credit rating, market prices have already voted with their actions. The stubbornness of long-term rates reflects global investors' distrust of the long-term purchasing power of dollar assets. When monetary policy cannot effectively intervene in the long end, it is essentially equivalent to a partial failure of central bank credibility. Sanders’ assertion that "you can still move the front end, but the back end doesn’t listen to you at all" is a straightforward description of this awkward reality.
The phenomenon of yield curve steepening thus becomes the most intuitive weather vane for observing the diminishing effectiveness of monetary policy. The dangerous signal it conveys is that the Federal Reserve is gradually devolving into a "local policymaker" that can only influence overnight rates in the money market, while its influence on core long-end rates that relate to the financing costs of the real economy, mortgage rates, and corporate capital budgets has dropped to historic lows. This "policy obsolescence" phenomenon is more concerning for the market than a simple pause in rate cuts.
3. Why lock in until 2026? The quadruple pressure of systemic risks and the logic of policy freezing.
The judgment to maintain interest rates until the second quarter of 2026 is not based on an optimistic outlook for the U.S. economy but rather a helpless response to the quadruple pressure of systemic risks. These four risks constitute a delicate "Impossible Quadrangle," making any interest rate adjustment potentially trigger a crisis in at least one dimension:
The first major risk: Rapid rate cuts will trigger a term premium crisis in the U.S. bond market. Rate cuts will narrow the spread between short and long ends, reducing the relative returns of holding long bonds, leading institutional investors (especially pension funds, insurance companies, etc., which have longer liability durations) to reduce their holdings of long-term U.S. Treasuries. In the context of continued supply expansion, shrinking demand will directly trigger a surge in long-term rates, forming an abnormal transmission of "rate cuts — long-term rates rising." This situation has already been previewed in the 2023 U.K. pension crisis; while the U.S. is larger and deeper, the basic principles are equally applicable. Powell is well aware that any aggressive easing signal could make the Treasury the biggest victim.
The second major risk: Slow rate cuts will exacerbate the hard landing risk in the labor market. Although the unemployment rate remains at historically low levels, the quality of non-farm employment data continues to deteriorate, with rising ratios of part-time jobs, slowing wage growth, and surging layoff announcements all signaling yellow lights. The Federal Reserve acknowledged for the first time in its fourth-quarter monetary policy report of 2023 that the labor market "shows signs of marginal softening," a dovish statement that instead triggered a panic rebound in the bond market, revealing a further narrowing of policy space. Maintaining high interest rates in the face of a clearly weakening economy could lead to a repeat of the mistakes made in the latter stages of the Volcker tightening in the 1980s, sacrificing deep recession for inflation stability.
The third major risk: Fiscal deficits and monetary policy trapped in a death spiral. In FY2024 to FY2025, the U.S. Treasury will need to issue a record-breaking more than $2.5 trillion in new debt to cover the deficit and roll over maturing debts. The level of interest rates becomes a critical variable: the higher the interest rates, the higher the proportion of interest payments to GDP, and the worse the fiscal sustainability; the lower the interest rates, the weaker the fiscal constraints, and the more reckless the deficit expansion. Any interest rate decision by the Federal Reserve may be interpreted by the market as an endorsement or indulgence of fiscal discipline, thereby exacerbating long-term inflation expectations. This situation of "fiscal hijacking monetary" is a typical symptom of monetary policy ineffectiveness.
The fourth major risk: The misalignment of global monetary policy cycles and imbalances in capital flows. Currently, major global central banks are in a rare period of policy divergence: the Bank of Japan is attempting to exit negative interest rates and raise rates, the European Central Bank is hesitating between falling inflation and sluggish growth, and countries like Australia are adopting ambiguous "data-dependent" strategies. Against this backdrop, any significant volatility in U.S. dollar interest rates will trigger violent cross-border capital flows through exchange rate channels, causing spillover shocks to emerging markets and potentially reversing U.S. financial conditions. The Federal Reserve must consider global financial stability, which further restricts its policy autonomy.
Historically, the Federal Reserve has employed a similar "policy freeze" strategy during three different periods: the early stagflation of the 1970s, the mid-1990s during the confirmation of productivity booms, and the long-term low interest rate policy after the 2008 crisis. Each freezing period, although under different macro backgrounds, was accompanied by drastic fluctuations in asset prices and significant differentiation between sectors. The current quadruple pressure may be even more complex and urgent than historical precedents.
4. Weakening labor market: The last variable triggering a policy stalemate.
Among many structural factors, the marginal deterioration of the labor market has become the last straw pushing the Federal Reserve toward a "locked-in" decision. Sanders particularly emphasized the chain reaction triggered by Powell's recent acknowledgment of a "softening" labor market: after the news was announced, the bond market not only did not drop due to easing expectations, but instead saw a rebound with an expanded term premium. This counterintuitive phenomenon reveals a key mechanism:
As the "central nervous system" of economic operation, the weakening of the labor market conveys two contradictory signals: on one hand, the slowing demand alleviates short-term inflation pressures, providing theoretical space for monetary policy easing; on the other hand, the deceleration of economic momentum exacerbates market concerns about long-term growth prospects, while the rigid spending requirements of fiscal deficits mean that the weaker the economy, the more the government needs to borrow to support demand, thus worsening long-term debt sustainability. This "short-end benefits, long-end harms" split directly leads to an exacerbation of yield curve steepening.
More complicated is the asymmetric risk of a weakening labor market. Against the backdrop of the current job vacancy rate still being higher than pre-pandemic levels, the marginal decline in labor demand may quickly translate into a non-linear rise in unemployment rates. The Federal Reserve has a very low tolerance for such "hard landing" risks, as it faces pressure on the employment target within its dual mandate and needs to prevent an economic recession from exacerbating fiscal deficits. Therefore, once clear recession signals appear in the labor market, the Fed's policy choices will fall into a real dilemma: "cutting rates could trigger a bond market sell-off, while not cutting rates could allow the economy to slide into recession." At this point, the optimal strategy can only be "wait" — neither raising rates to curb potential inflation rebound nor lowering rates to stimulate potentially overheated fiscal financing demands, sacrificing time to allow structural issues to naturally soften.
Madison's mild statement that "the pace of easing will slow" essentially conveys a policy helplessness to the market: the Federal Reserve is no longer unwilling, but unable. The limitations of the toolbox, the conflicts between targets, and the complexity of the internal and external environments collectively constitute a rigid constraint on policy.
5. Reconstructing investment paradigms: Finding certainty anchors in a "policy vacuum period."
When interest rates are locked in until 2026, the traditional framework for asset allocation based on central bank policy cycles will partially fail. Investors must recognize that in the next two years, the dominant market trend will no longer be the Federal Open Market Committee (FOMC) meeting statements, but rather the microstructure of capital flows and the structural changes in the macroeconomy. Specifically, the following six asset areas will face fundamental reassessment:
1. Long-term bond market: High volatility coexists with term premium risks. Under the dual pressure of supply-demand imbalance and credit risk reassessment, the pricing of U.S. Treasuries with a maturity of 10 years or more will reflect fiscal sustainability more than monetary policy expectations. This means a significant increase in duration risk, and the safe-haven attributes of traditional bonds will weaken. Investors need to shorten duration, increase sensitivity to changes in credit spreads, or adopt a steepening strategy to hedge.
2. U.S. dollar exchange rate: The tug-of-war between structurally high interest rates and fiscal risk hedging. While the locked-in interest rates provide a yield advantage for the U.S. dollar, concerns about fiscal irresponsibility will undermine its long-term status as a reserve currency. The dollar may enter a wide trading range, lacking both catalysts for trend depreciation and fundamental support for sustained strengthening. For cross-border investors, exchange rate hedging costs will become a significant erosion of returns.
3. Gold and digital assets: The prominence of non-sovereign value storage functions. As the credibility of sovereign monetary policy declines, and fiscal overextension threatens currency purchasing power, gold and de-sovereignized assets like Bitcoin will gain systemic premiums. Unlike traditional commodities, the prices of these two types of assets reflect not only inflation expectations but also option pricing on the stability of the monetary system. During the period of locked-in interest rates, their correlation with risk assets may turn negative, becoming a genuine diversification tool in the portfolio.
4. Technology stocks: From valuation expansion to the reassessment of profit quality. The stickiness of long-term risk-free rates will end the valuation myth of "long-duration growth stocks." The market will shift from optimistic discounts of future cash flows in DCF models to a harsh examination of current profitability and cash flow stability. Technology companies with pricing power, high profit margins, and controllable capital expenditures will stand out, while "story-driven" tech stocks that rely on low financing costs for expansion will face downward adjustments in their valuation centers.
5. Emerging Markets: Extremely sensitive to marginal changes in global liquidity. Against the backdrop of high locked-in U.S. dollar interest rates and increased exchange rate volatility, emerging market assets will show a clear "binary differentiation". Economies with a robust current account, low levels of external debt, and good fiscal discipline may attract safe-haven capital inflows; while countries reliant on external financing and facing high deficits will face dual pressures of capital outflows and currency depreciation. Overall volatility will be significantly higher than in developed markets.
6. Cryptocurrency: Leading indicators of liquidity changes and risk amplifiers. Compared to traditional financial markets, the cryptocurrency market is more sensitive to changes in global liquidity, and due to the still-imperfect regulatory framework, its price volatility can more honestly reflect the risk aversion sentiment and speculative preferences of marginal funds. During times of mixed signals from the Federal Reserve, mainstream cryptocurrencies like Bitcoin and Ethereum may reach their bottoms or tops ahead of traditional assets, becoming the "canaries" for observing global risk appetite.
Conclusion: When the central bank’s toolbox runs dry, how the market rewrites pricing rules.
The judgment of Madison Investment Company essentially reveals an unsettling truth for the market: the Federal Reserve's toolbox is nearing its effectiveness boundary. The interest rate lock-in is not a proactive choice made with strategic foresight but a passive defense under siege from all sides. When the central bank clearly conveys the signal "I have little room to maneuver, don't expect me to help you out next," the power to establish pricing rules begins to shift from policymakers to market participants.
From 2024 to 2026, the real storyline of the global financial markets is not whether the Federal Reserve will raise or lower interest rates by 25 basis points, but how the market will reprice risk assets under a new paradigm of fiscal imbalance, structural dislocation, and credit overextension. In this process, certainty will become scarce, and "uncertainty itself" will become the greatest certainty. Investors must abandon their inertia in relying on policy easing and instead build a "post-monetary policy" portfolio centered on cash flow, credit quality, and non-sovereign hedging.
Historical experience shows that each collapse and reconstruction of the monetary policy framework is accompanied by a large-scale transfer of wealth. Those investors who can first understand the logic behind the "interest rate lock-in" and decisively adjust their strategies may seize the initiative in this silent revolution. #Federal Reserve Policy #Interest Rate Lock-in #U.S. Treasury Crisis #Structural Inflation #Global Asset Allocation #Monetary Policy Ineffectiveness #Fiscal Deficit #Yield Curve #Labor Market #Cryptocurrency Hedge $BTC
