Those who believe that a cut in short-term rates, while inflation remains undefeated, will reduce what the U.S has to pay to borrow will be disappointed.

With the approaching Fed decision in focus, some bracing thoughts from economist Robin Brooks:

There’s no hard science on what makes a given stock of government debt unsustainable. A debt ratio of 100 percent to GDP can be perfectly fine as long as bond markets are willing to buy your debt at low interest rates. But if some kind of shock comes along and markets panic, all of a sudden that same debt ratio of 100 percent becomes a problem.

This is all too true. When some event (and who knows what that will be) starts leading to a reevaluation of risk that catches on and prices start falling (assuming the reevaluation is negative), other investors will follow suit, not because they will have done the math or necessarily changed their minds, but because they will not want to be last out the door.

If sentiment turns strongly negative, the expense (and implicit career risk for the traders involved) of hanging on too long to newly unpopular securities can rise dramatically, as it becomes more and more difficult — and thus more and more expensive — to find a buyer for paper the dilatory trader is now desperate to dump.

This is one aspect of “contagion,” fear of which drove the policy response to both the eurozone and great financial crises. The essence of contagion is, by definition, that it spreads. One seller triggers another, the collapse of one asset class triggers the sale of others. It’s a process that can go a very long way, with effects that can show up in some unexpected places.

The dreaded bond vigilantes are stirring, particularly, Brooks demonstrates, when it comes to their attitude to longer-dated (ten years or beyond) bonds. That makes sense: The longer a bond’s remaining term, the greater the intrinsic risk, and the greater the perception of that risk. If much of that that risk is inflation, the brutal math of compounding (to oversimplify) will mean that the biggest hit to current prices as a result of rising inflationary expectations is for those of longer-dated bonds.

Brooks’s analysis is complex (look for yourself) but his conclusion is that, with Germany and Japan having fallen by the wayside, the only safe-haven bonds that remain are Swiss. “The reward,” he writes, “for being a low-debt country has gone up substantially in markets.” The U.S., he does not have to add, is not a low-debt country, although there are other reasons, rooted in geopolitics and the strength of the underlying economy, why Treasuries would still retain some (if tarnished) safe-haven status in the event of a major crisis.

Switzerland is a small, disciplined country, and there are not that many Swiss francs to go round. Continuing inflows into that currency are thus pushing the franc up quite some way. A Swiss franc buys $1.27 today, against $1.10 at the beginning of 2025. Swiss short-bond yields are slightly negative, the ten-year yields a princely 0.16 percent (versus a little over 4 percent for the U.S.). Switzerland runs a small budget surplus, and net government debt/GDP is around 37 percent. That helps.

And then there’s gold. Gold is up nearly 40 percent against the greenback year-to-date, silver a little more.

All that would suggest that those who believe that a cut in short-term rates at a time when inflation has not been defeated, will, in the end, reduce what the U.S has to pay to borrow will be disappointed.

Meanwhile, Cato’s Jai Kedia, who sees a 25 basis-point rate cut “as the most likely outcome” (FWIW, I’d agree) writes:

last week’s inflation report shows that prices are increasing much faster than the Fed’s 2 percent target, indicating real concerns of a supply shock that has caused both inflated prices and unemployment. In such situations, guidance for monetary policy is ambiguous, with a standard monetary policy rule advocating no change to rates or even a slight increase.

And that sounds right, both on the economics and for the signal it would send about the Fed’s independence. Suggestions that the latter is waning will sooner or later prove very expensive indeed.