The risks of U.S. Treasuries are now visibly apparent—so will the Fed really raise rates in September? Raising rates would push up Treasury yields and increase the U.S. Treasury’s borrowing costs. ┈➤ The "Ambiguous" Relationship Between the Fed and the Federal Government Although the Fed is independent, its relationship with the Treasury is undeniably complex. ╰✦ The Fed remits net profits to the federal government On one hand, although the Fed operates on a self-funded basis, it is required to remit its net profits to the U.S. government. The federal government provides no funding to the Fed. After covering operational costs, paying dividends to member banks, offsetting prior losses, and retaining statutory reserves, the Fed transfers the vast majority of its remaining net income to the U.S. Treasury. ╰✦ The Fed’s primary income comes from U.S. Treasuries On the other hand, the Fed’s main source of income stems from holding U.S. Treasuries issued by the Treasury (under normal conditions). The Fed injects dollar liquidity into the market by purchasing Treasuries and mortgage-backed securities (MBS). Buying or selling Treasuries is one of the primary mechanisms of QE and QT. As a result, the Fed holds a large portfolio of Treasuries long-term, with interest payments from these bonds constituting its primary revenue stream. Additionally, during QE, the Fed purchased MBS and has continued holding them since; these also generate interest income. However, in most years, interest from Treasuries remains significantly higher. The Fed also earns income by providing discount lending and other services to commercial banks—but unless during a crisis, this revenue is typically minimal. Thus, overall, U.S. Treasuries remain one of the Fed’s primary sources of income. So, can the Fed raise rates without any regard for the impact on U.S. Treasuries and the federal government? ┈➤ Must Inflation Always Be Tackled With Rate Hikes? I’ve analyzed this countless times: inflation driven by oil prices cannot be cured by raising rates. Rate hikes primarily aim to dampen wage growth expectations and break the “wage-price spiral.” Therefore, even the mere expectation of rate hikes may serve this purpose. Whether the Fed will hike in September still depends on two more months of data—July and August. If CPI does not worsen, the Fed may very well hold off. ┈➤ Final Thoughts On one hand, I don’t believe a September rate hike is a foregone conclusion. Given the intricate relationship between the Fed and the federal government, can the Fed truly act without any regard for Treasury markets? On the other hand, market expectations for a September hike have already been priced in—the rise in Treasury yields essentially reflects that markets have already anticipated rate hikes. I believe quantitative tightening (QT) may be more appropriate than rate hikes. QT also creates a tightening expectation and helps curb wage growth expectations, thereby helping to break the “wage-price spiral.” Observing monthly U.S. wage growth data, there is no sign of accelerating wage increases. The key difference between QT and rate hikes: each rate hike delivers an immediate, blunt tightening effect, while QT is a gradual process. With QT, as the Fed’s held Treasuries mature, they are not fully reinvested—this reduces demand for Treasuries incrementally, resulting in a milder impact on Treasury markets. And as Walsh has long advocated: first QT, then rate cuts. Of course, this is my personal view. The Fed’s final decision will still depend on developments in U.S.-Iran relations and inflation trends over July and August.