Policy, Politics, and the Fed's 'Third Mandate'

For decades, central bankers have anchored their credibility to two guiding stars...

The first is full employment. And the second is price stability.

This "dual mandate" has been sacred for most of modern history. The Federal Reserve isn't meant to juice the economy or help politicians manage deficits. Its job is to keep inflation under control while supporting a healthy labor market.

But another idea has crept back into the conversation...

During recent Senate testimony, Trump-appointed Fed nominee Stephen Miran invoked a long-forgotten clause from the original 1913 Federal Reserve Act – maintaining "moderate long-term interest rates."

Soon after, Treasury Secretary Scott Bessent echoed the same point in a Wall Street Journal op-ed.

Bond traders see this as a warning sign. And so do we.

The reemergence of the Fed's 'third mandate' is no accident...

As Bloomberg reports, the clause – which was buried in the original Fed charter – has been dormant for most of the central bank's history. It's referenced only in moments of extreme national stress, like during World War II or the 2008 financial crisis.

Today's environment hardly qualifies as a crisis. Inflation is slightly above target... but it's not spiraling. The labor market is cooling... but it's doing so at a manageable rate.

There's no macroeconomic reason to revive this clause.

There is, however, a political one...

The U.S. is staring down more than $37.4 trillion in national debt. Annual deficits run north of 6% of GDP.

That creates a simple incentive for the administration to keep our debt in line. Lower long-term interest rates would ease the pain of debt service. And they'd make room for more spending.

But the third mandate could also have unintended consequences...

Officials at the Fed and the Treasury risk losing sight of proper monetary policy.

This mandate is just quantitative easing ("QE") under a different name. Through QE, the Fed influences the money supply by buying assets like U.S. Treasurys and mortgage-backed securities. This pushes cash into the market and creates more money for banks to use to issue loans.

In the past, QE has been used to get us through periods of crisis. That's not what we're seeing now.

The other effect of QE is its power over long-term yields. The more assets the Fed buys, the lower yields will be based on simple supply and demand.

When the central bank starts serving fiscal priorities, it can't be trusted to prioritize its actual responsibilities, like inflation control. Investors stop believing the Fed will "do what it takes"... and inflation expectations become unanchored.

That's the danger of politicized monetary policy.

Warning signs are already cropping up...

Despite a cooling labor market, 10-year Treasury yields remain elevated. This is likely because investors are getting worried the Fed will prioritize its third mandate.

More alarming, long-term bond buyers are starting to demand inflation protection. Some are buying shorter-term Treasury Inflation-Protected Securities ("TIPS") – Treasurys with yields that change alongside inflation.

Investors only bought $8 billion in TIPS in August. They bought $20 billion last month.

The bond market is clearly concerned. And regardless of where you're investing your money, you need to stay alert.

A Fed pivot toward the third mandate won't be announced in a press release...

It will show up gradually in the behavior of longer-dated bonds.

The central bank is cutting interest rates. It's no longer so concerned with tamping down inflation. And as inflation creeps higher, Treasury yields should rise.

If 10- or 30-year yields stay steady, that's a flashing red light. It would mean the Fed is coordinating with the Treasury to manage the curve.

And that would be a reason for investors to lose trust in the Fed's inflation-fighting credibility.

The market is still priced as if the Fed is independent... for now. If this "third mandate" becomes more than talk, things could change fast.

Regards,

Joel Litman
October 20, 2025