federal reserve

Some Ways for Investors to Hedge Against Higher Interest Rates

Scott BuchananLeave a comment

Coming into 2026, all the chatter was about cutting short term rates (which the Fed does directly by fiat). Long term rates, which are generally set by the broader financial markets, were more or less steady, despite the angst over ongoing gigantic federal deficits; the world remained ready to absorb T-bonds, since they are regarded as the most liquid and secure yield-bearing instruments for global finance.

The Iran war has changed all that. The administration, like other administrations in other conflicts over the past half-century, apparently underestimated the adversary’s resilience in the face of bombing. Without further comment on the geopolitics, it suffices for our purpose as investors to assume that there is a good chance that the conflict will continue for some time, and thus oil prices will remain elevated. This works through the system as persistent inflation, even if the immediate effects of consumer gasoline prices are stripped out of the inflation measure. Bond buyers naturally must take into account expected inflation in pricing what rates they are willing to pay for. Also, the unprecedented boom in data center construction is competing for investment dollars. And so, the ten-year T-bond yield has surged from 4% in late February to over 5% now.

As everyone knows, the price of existing long-term fixed debt (e.g., T-bond, corporate bond, etc.) goes down as rate go up, since the existing bond now has to compete in the market with new, higher yielding bonds. Thus, bondholders are crying in their soup, as the price of IEF (ETF that holds 7–10-year T-bonds) has dropped 7% year to date, and the longer-termed (20+ year) TLT is down 10%. Those are big hits to what are thought to be safe, secure holdings.

What can investors do to protect themselves against further rate increases? One approach is simply to avoid holding long-term bonds or bond equivalents (fixed-rate debt). You can hold very short term (e.g. 3-month) T-bills, as in the TBIL fund.  Or you can hold instruments with floating rather than fixed rate. For instance, FLOT holds floating-rate government debt, PAAA is a complex but AAA-rated ETF, and many preferred stocks (e.g., NLY-F) also pay some fixed increment above the current market short-term rate. The values of these instruments are relatively insensitive to overall interest rates.

For a more direct hedge, that goes up when long-term bonds values go down (i.e., when rates go up), there are several funds that use derivatives that essentially short T-bond values. TBT is a straightforward, plain vanilla -2X short of the 20+ year T-bond index. With TLT down 10%, TBT is (unsurprisingly) up a full 21% YTD (total return).  PFIX is an actively-managed fund that does something similar, but with wilder swings. It is up a sizzling 30% in 2026, but it was down by 12% in late June. Most advisors seem to recommend TBT or PFIX for tactical trading only, to hold only when you have conviction that rates are going up soon. If the Fed come out swinging tomorrow with a QE bazooka to drive down rates, these stocks will likely crater.

RISR takes a middle ground, it holds interest-only strips of mortgage-backed securities, so it brings in a decent current yield (5.8% now), and its value rises somewhat as rates go up. Its total return YTD is 6.2% – – maybe not something to brag about at a cocktail party, but it beats CDs.

Here is a 3-year chart of some of these stocks (total return):

Another strategy is to buy individual bonds and hold them to maturity, so you know exactly what the final payout will be.

Saving the best for last: it turns out that if you are a homeowner with a fixed-rate mortgage, you are effective “short” long-term debt, so you “own” a primo hedge against rate increases. Congratulations!

Disclaimer: Nothing here should be considered advice to buy or sell any security.

The World Keeps Spinning Faster

James Bailey1 Comment

So many things are happening that it’s hard to decide which to write about. So I’ll briefly cover several that would each deserve a full post on a normal week:

1. The Fed voted unanimously to raise rates to 4%, showing that the Warsh Fed still has some independence from the President.

2. The 10-year Treasury bond hit 5%. The CBO’s long-term budget forecasts assume 4% rates for the 10-year, and looked unpleasant even with that rosy assumption. The UK dumped Prime Minister Liz Truss over their 10-year hitting 4.5%.

3. Jacob Coxon resigned from Anthropic over AI safety concerns and set off a surprisingly large firestorm over it.

4. The Trump administration reacted by insisting we move forward with AI, with the Department of War blaming Effective Altruists for trying to slow it down:

I suspect this could lead many people to get into Effective Altruism by promoting it from ‘weird thing for nerds‘ to ‘something you can do to oppose Trump’. If that interests you, this is a good place to start.

5. EA hero Michael Kremer (whose work inspired many donations to deworming) was just appointed Chief Economist of the World Bank.

6. But AI progress keeps rolling. Quantum theorist Scott Aaronson declares the Singularity is here:

I recoil from the neverending shell game where you say “oh sure, of course AI can now [escape from its sandbox / solve Millennium Problems / whichever dramatic thing it most recently did], no one ever denied that [I did deny it], wake me up when AI does [thing AI hasn’t yet done but is going to do next year], that’s when I’ll reevaluate my whole worldview [no I won’t].” Where no matter how fast the rollercoaster accelerates, even after your whole familiar world has vanished behind you, you’re still inventing reasons why it doesn’t count.

My position on AI is merely the conservative, skeptical position of 2006, updated with intellectual honesty for the reality of late 2026. And that position, if you need me to spell it out, is as follows:

AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA
AAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAA

It seems to me that the Singularity has already started; it’s just wildly unevenly distributed.

I’m honestly surprised we have yet to see an upsurge of millenarianism. Y2K concerns came and went 2000 years after Jesus’ birth. But see how much people worry about AI now, and realize it will only get more powerful as we approach 2000 years after his death- 2033, or if you trust the revisionists, 2030.

Bond Market Blows Off Treasury Bond Buyback; Gold and Bitcoin Soar

Scott BuchananLeave a comment

Scott Bessent used to be a serious financial player. When he was with George Soros’s fund, he helped them make a billion dollars in 1992 by betting against the British pound, and $1.3 billion in 2013 with a bet against the Japanese yen. He also ran his own hedge fund, with as much as $5 billion under management. In 2023-2024 he hitched his wagon to the fortunes of Donald Trump, becoming a large campaign contributor and fundraiser. He was rewarded by being made Treasury Secretary. On January 27, 2025, the U.S. Senate voted to confirm Bessent’s nomination. (The same day, a man with multiple Molotov cocktails and a knife who intended to murder Bessent was arrested at the United States Capitol, an event seemingly lost in the noise of all the attempted assassination attempts against this administration).

The current administration has continued the policy of the previous administration of profligate peacetime federal deficit spending, some 6% of GDP annually, well above the 50-year average of about 3.8%. The only way to finance this spend is to sell more and more Treasury debt. But the more of that debt is out there, the more interest needs to be paid on it. By the mid-2030’s, interest payments will balloon to the point that they, plus mandatory transfer payments like Medicare/Medicaid/Social Security, will consume 100% of tax revenues, with nothing left for discretionary spending (including defense). Being the cabinet officer responsible for financing this mess now is sort of like being CFO of Lehman Brothers in 2008.

Which brings us to the ignominious market response to Bessent’s attempt at bond market intervention last week. As it has become more and more clear to the rest of the world that the U.S. has no intention of reining in its deficit, but instead hopes to deal with it by inflating away the value of the dollar, the market has started to demand greater compensation for holding long-term U.S. debt. If you are wondering why you now have to pay 6.65 % for a 30-year mortgage, wonder no longer. These high interest rates are making it all the more painful for Treasury to fund the deficit.

Secretary Bessent made a surprise announcement last Wednesday that his department would double its maximum purchase of older, less-liquid long-term bonds, from $2 billion per week to $4 billion. The stated purpose of this long-running buyback program is to retire hard-to-trade bonds and replace them with newer, more-liquid bonds. That’s fine, but this snap announcement shortly after its quarterly refunding plan broke with Treasury’s long-held strategy of making ‘regular and predictable’ announcements, and (together with statements by Bessant threatening further intervention) was widely seen as an attempt to talk down the long-term rates.

It worked for about one day. Long term yields initially dipped Wednesday morning by about 0.1%, but by Thursday they were about back to where they were before the announcement. Not only did traders realize the size of the intervention was far too small to move the enormous T-bond market (and would not net decrease T-bonds outstanding), but Treasury’s move became interpreted as a sign of desperation over funding the U.S. deficit. That vibe will not help bring down Treasury bond rates going forward. The value of the dollar dipped on world exchanges, while the price of alternatives such as gold and Bitcoin soared:

That is a chart of Bitcoin price in the past month. HODLers rejoice, the long crypto winter may be over…

Fiscal Trends: USA’s 250th (And the Government’s 237th)

Zachary BartschLeave a comment

We celebrate 250 years since the Declaration of Independence was signed on July 4th, 1776. That’s the day that we celebrate our country’s birth. So, it’s very American of us to celebrate the day that we merely declared independence (not the day that the revolutionary war ended). We simply said we were independent from the crown. Regardless, we celebrate 250 years as a people. BUT, our government is only 237 years old.  The current constitution replaced the articles of confederation in 1789.  So there are some caveats to the whole semiquincentennial thing.

An important distinction that is baked into the American pie is that we are not our government. Our government is younger than we are. Our government has a piggy bank called ‘US Treasury’. It can spend and borrow for the US national government. It can also impose tax liabilities on the population in order to service those outlays. Now that it’s the government’s 237th birthday, what’s its basic financial track record?

I like to think in the long run, for better or for worse, and I don’t like to get hysterical. So, let’s look at the full span of the 237 years – well – 235 years. The oldest annual data that we have is from Bicentennial Historical Statistics, which goes back to 1792. Below are the series for Federal Receipts and Outlays (revenue and spending).

The blue line is in nominal dollars and the orange line is the natural log so that we can see the changes in growth rates more easily. These aren’t inflation adjusted numbers, so we should expect to see some inflationary patterns. Long-run inflation was pretty stable prior to the 1913 Federal Reserve act and wee can see that reflected in both series. There was some drift upward in terms of revenue and expenditures. But the primary pattern was one of punctuated rises followed by plateaus. That’s a pretty standard ratcheting leviathan pattern. There’s a bump up for the big events in the first half of our history: the War of 1812, Civil War in 1861, and World War I in 1917.

Then, after the great depression and leaving the gold standard (mostly), in about 1933 a new and positive trend in cash flows began. In fact, it’s amazing how consistent the raw nominal series is.  We can see where World War II is in the series, but after that we appear to have traded punctuated increases for steady increases. Even the higher inflation rates of the 1970s look pretty muted and on trend (Btw, the blip in 1976 is a record-keeping artifact. There was a 3 month gap-period when the US government changed its fiscal year start/end). Even the new growth in total cashflows seems to be slightly bending downward and growing a little more slowly.

But rest assured, spending has exceeded revenues. Below is the long run deficit. I don’t take the log for this one since there are negative numbers. It’s hard to tell from the line graph, but the first big and persist swing in the deficit arrived after the Fed was established and the onset of WWI. The deficit hit $9 billion in 1918, which was 10x the prior peak of $0.9 billion at the end of the civil war in 1865. Notice that the above government revenues stayed flat or fell after 1920, but the outlays began trending upward before the revenues. The deficit doesn’t really start its long, steady march until 1932. Of course, for the past quarter century, the national government has been in a deficit mess (even if you measure the proportion of GDP).

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What the Fed Knew, and When

Zachary BartschLeave a comment

I’ve recently gone back and started listening to the archived episodes of the ‘Macro Musings’ podcast hosted by David Beckworth. The show started in 2016. At that time, there was still a sense of malaise after the 2007-2008 Great Financial Crisis (GFC) and the slow recovery that followed it. We were also in a prolonged low-interest rate environment.

A recurring theme is whether the Fed should have engaged in expansionary policy earlier than they did in response to the GFC. There are multiple ways to answer. It’s not helpful to say ‘knowing what we know now’. The Fed didn’t have that opportunity. It’s a little bit more helpful to say ‘if the Fed had a different target or different tools’.  The target and tools are higher-order policy decisions and changing them can be helpful in the future. But they typically can’t be changed with the flip of a switch. After all, the 2% inflation target itself rolled out over the course of decades.

The most awkward/damning question is “Given the target, tools, and data that the fed actually had, did they make the right decision?”. If the answer is ‘no’, then that warrants a serious investigation of individuals, groups, processes, etc. I don’t mean a legal investigation. I mean the decentralized kind in which public and expert trust can be affected.

A concept that Beckworth often mentions concerning Fed culpability/performance during the GFC is the problem of data revisions. Currently, we know what the revised data says about NGDP, inflation, employment, etc. But the Fed only had the contemporary numbers and immediate revisions. In a world where economic growth is lousy or stellar in a range of 1-3%, small revisions can matter a lot. For example, below are the 2001q1 NGDP revision values over time.

Revisions occurred twice by 2002q2, revising NGDP down by more than 2%. Subsequent revisions raised the value on record to nearly +3% of the initial estimate, before settling at a less elevated value. Sheesh! In a world where a 1% swing is a big deal, how can we possibly expect the Fed to succeed at managing aggregate demand?

Things are not so scary as they might seem. The Fed doesn’t much care about revisions to an individual quarter. Rather, they care about the direction of change over time. Whether future revisions increase GDP by 2% is unimportant. What’s important is whether one period’s value is lower relative to the earlier value. That’s the relevant difference that tells us how the economy is changing.

Now, in 2026, our current understanding of NGDP during the GFC follows the below pattern starting in 2005q1 (lest I omit important pre-trends). NGDP growth had weakened in 2007q4, turning negative in 2008q1. Weak growth resumed in 2008q2. Then we had near-zero or negative growth for the next five quarters. Of course, we’re now approaching twenty years later, so we have the huge benefit of hindsight and revisions. Keep in mind that the contemporary numbers aren’t available until the subsequent quarter. By the yard stick of NGPD, the Fed should have been loosening by Q3 or certainly Q4 of 2008 if they cared about supporting total spending. Maybe as early as Q2 is they were especially sensitive.  

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Greenspan’s Unknown Ideal

James Bailey1 Comment

Alan Greenspan died this week at age 100. He was the Federal Reserve chair during my entire childhood.

But since I wasn’t really following markets and macro at the time, I don’t think of him in terms of monthly announcements about interest rates. What I find most interesting now is the winding personal and intellectual path he took to become a long-serving Fed chair.

He studied clarinet at Julliard before later getting economics degrees at NYU. He supposedly attended the famous 1944 Bretton Woods conference that organized the post-war international monetary system- but as part of an orchestra, not as a monetary economist. In 1966 he coauthored “Capitalism: The Unknown Ideal” with Ayn Rand, where he argued against antitrust and consumer protection laws and for the gold standard. This may be why my intro macro professor Bobbie Horn always referred to Greenspan as “Ayn Rand’s boy toy”.

His advocacy for the gold standard is striking given that just two years later he would join the campaign of Richard Nixon, who took the US off the gold standard in 1971. Then Greenspan would go on to chair the Fed in the now-standard discretionary manner while making, as far as I can tell, no attempts to move it back in the direction of a gold standard.

While it’s unclear whether Greenspan’s unusual path improved his ability as a Chair, it was at least possible then to reach the office by his somewhat unusual path. Since his 1987 appointment the path to the highest appointed offices narrowed to include only more conventional candidates. Randy Barnett and Josh Blackman noted this in a 2015 article on the Supreme Court:

earnest, platinum-résumé’d law geeks have their eyes set on “the Big Bench,” so they keep tidy lives because they think they might someday face a confirmation hearing. It is an unfortunate reality today that to be a judge, you cannot hold vehement opinions prior to the nomination and confirmation process.

I see similar forces at work in economics, where the 50 economists who have a shot at being Fed Chair and the 500 who think they do all hold their tongues. But what does that mean for the kind of Fed Chairs we get?

the truth about SCOTUS-wannabes who “trim their sails” and limit their potential based on a fear of a future confirmation hearing: Such persons lack the character a justice needs…. “Courage is a muscle. You develop courage by exercising it. Sitting on the fence is not practice for standing up.” Imagine what it takes to live your whole professional and personal life as a “justice-in waiting.” These SCOTUS-wannabes spend their careers seeking the approval of others, in the hopes that one day they will be nominated because of their friendships across the political spectrum. 

Barnett and Blackman argued that this should change, and I think this is now in the process of changing again:

Such willfully “stealth candidates” should be disqualified from consideration for the Supreme Court…. We need jurists who are fearlessly committed to the rule of law, reputation be damned…. Paper trails are an asset, not a disqualification.

Raise Rates- But Not Because Of Oil

James BaileyLeave a comment

Next week the Fed will almost certainly hold interest rates steady. Stephen Miran will probably dissent saying the Fed should be cutting rates. Kevin Warsh, Trump’s nominee for Fed Chair, would also like to see cuts. But other prominent voices think that rising oil and gas prices mean we should be raising rates.

I still think that rate hikes make more sense than cuts- but not because of oil. The high oil and gas prices we’re seeing are obviously driven by supply shocks from the Iran war- not increasing demand. Raising rates to fight an oil shock would mean repeating a classic mistake.

But raising rates to fight core inflation that is at 3% makes perfect sense. Especially when inflation (overall or core) hasn’t been at or below the Fed’s supposed 2.0% target in over 5 years, and market forecasts predict it will stay well above 2.0% for the next 5 years.

Especially when real GDP is growing, and NGDP is still above trend, and the unemployment rate is 4.3%. Financial conditions are so loose that stock markets are hitting all time highs in the middle of a war.

Various Taylor Rules suggest that the Fed Funds rate should be between 4.25% and 6.25%, but the Fed currently has us at 3.75%.

I see so many good arguments to raise rates- there is no reason to bring up a bad one like oil prices. If we must latch on to a headline to find the argument to raise rates, let’s focus on a shoe company’s stock going up 600% because they announced they were pivoting AI.