Is the interest rate locked until 2026? Don't focus on 25bp; that's just an appearance. The real danger lies in the triple pressure of bonds, markets, and politics squeezing the Federal Reserve—analyzing the deep logic behind the U.S. monetary policy's structural deadlock and its impact on global asset pricing

Madison Investments recently issued a strategic judgment that casts a shockwave beneath the calm surface of financial markets. The firm explicitly states: "The Fed may need to keep current interest rates until Q2 2026." The reason this forecast triggers deep market anxiety isn't the duration itself, but the fundamental shift in monetary policy logic it reveals—this is not a traditional "pause in rate cuts" or "hawkish wait-and-see," but an almost "Rate Freeze" state: prolonged high-level freezing, holding steady, actively losing policy flexibility.

When a core economy's benchmark rate remains at restrictive levels for over two and a half years, its significance transcends a simple extension of the monetary tightening cycle. It implies a systemic reassessment of asset pricing benchmarks, risk premium models, and cross-asset correlation systems. Compared to cyclical adjustments like rate hikes or cuts, this "policy static" state harbors more covert risks but is also more destructive. However, what’s truly worth vigilance isn't the conclusion itself but the underlying logic driving it: the Fed isn't proactively choosing this path but is forced into it by bonds, markets, and political pressures—a suboptimal second-best solution. This article will analyze the formation mechanism, technical features, systemic risk transmission pathways, and strategic insights for global asset allocation arising from this policy deadlock.

1. Limitations of Monetary Policy Tools and the Formation of "Rate Freeze" Expectations

Madison's chief economist Saunders highlights a core overlooked by markets: "The impact of monetary policy on markets is significantly limited." This statement fundamentally questions the effectiveness of traditional monetary policy. Over the past forty years, both markets and policymakers have habitually viewed interest rate tools as the universal key to adjusting economic cycles—raising rates to curb inflation, lowering to stimulate when growth is sluggish. But the current challenge facing the US economy isn't cyclical overheating but deep structural distortions.

Specifically, these limitations manifest in four reinforcing dimensions:

First, uncontrollable expansion of fiscal deficits. The Congressional Budget Office (CBO) projects that the federal deficit in fiscal year 2024 will reach 6.8% of GDP, far above historical averages. More severely, this deficit expansion isn't a temporary wartime or crisis measure but a structural imbalance under full employment. When expansionary fiscal policy continually offsets monetary tightening, the rate tool's ability to suppress aggregate demand diminishes significantly. Each 1 percentage point rate hike's demand contraction can be easily offset by incremental fiscal stimulus.

Second, the anchoring of long-term inflation expectations has failed. Although short-term inflation data has retreated due to base effects, long-term inflation expectations haven't stabilized within the 2% target. The NY Fed survey shows the median three-year inflation expectation remains above 3%. This stickiness reflects market skepticism about the de-inflation process—factors like supply chain restructuring, energy transition, and structural labor market tightness make demand management alone insufficient to resolve cost-push inflation.

Third, nonlinear deterioration in the labor market. Surface-level low unemployment masks underlying issues like persistently low labor force participation, imbalanced vacancy structures, and sluggish real wage growth. The flattening of the Phillips curve means the policy trade-off between curbing inflation and protecting employment is severely compressed. Any rate adjustment risks two adverse scenarios: rate hikes could rapidly cool the labor market; rate cuts could unanchor inflation expectations.

Fourth, oversupply of US debt and term premium distortions. To fill fiscal gaps, the Treasury must continually expand bond issuance, especially of long-term debt. With major foreign central banks (e.g., PBOC, BOJ) reducing holdings and domestic banks facing deposit outflows, demand elasticity for long bonds weakens. This directly causes a breakdown in the transmission of monetary policy—while the Fed can target short-term rates precisely, its influence over the 10-year and beyond yields sharply diminishes. The "stickiness" of long-term rates reflects market risk pricing regarding the US’s long-term fiscal sustainability, not just monetary policy expectations.

This confluence of structural issues prompts the market to reassess the Fed's policy space. Every rate adjustment is no longer merely a cycle management but a precarious balancing act—more movement risks exacerbating conflicts; inaction may be the safest "active defense." This is the core reason why "Rate Freeze" expectations are rapidly fermenting.

2. The "Steepening" Anomaly of the Yield Curve: Technical Evidence of Diminished Monetary Efficacy

Under traditional monetary policy frameworks, a rate-cut cycle typically features a downward shift and flattening of the yield curve—short-term rates drop rapidly with policy easing, while long-term rates decline more modestly but in the same direction. Currently, an abnormal phenomenon is observed: short-term rates are declining with easing expectations, but long-term rates are not only refusing to fall but recently have rebounded sharply, leading to a "Bull Steepening" and "Bear Steepening" oscillation.

This technical pattern stems from three deep contradictions:

First, self-fulfilling structural inflation expectations. Participants recognize that current inflation pressures can't be cured solely through demand management. Factors like nearshoring in supply chains, massive capital expenditure for green transition, and geopolitical fragmentation underpin long-term inflation. Therefore, even if the Fed cuts rates temporarily, long-term inflation expectations won't be revised downward; instead, markets may worry about being "behind the curve," raising long-term premiums.

Second, persistent fiscal dominance over long-term yields. With ongoing US fiscal deficits and no signs of convergence, rate cuts reduce debt service costs, potentially incentivizing further fiscal expansion. Rational market expectations demand higher term premiums to compensate for future debt monetization risks. Under "Fiscal Dominance," monetary policy effectively loses independence, with long-term yields serving as an implicit fiscal constraint.

Third, implicit downgrades of long-term credit ratings. While agencies haven't officially downgraded US sovereign credit, market prices have spoken. Persistent long-term rates reflect global investor distrust in USD assets' long-term purchasing power. When monetary policy can't effectively influence long yields, it essentially signifies a partial failure of central bank credibility. Saunders's statement that "front end can still be moved, but the back end is beyond your command" captures this awkward reality.

Therefore, the yield curve steepening anomaly is the most intuitive indicator of diminishing monetary policy efficacy. It signals that the Fed is gradually devolving into a "partial policymaker," mainly influencing overnight rates, with its influence over core long-term rates—mortgage, corporate capital costs—at a historic low. This "policy sidelining" phenomenon is more concerning than mere pauses in rate cuts.

3. Why Lock Until 2026? The Fourfold Systemic Risks and the Logic of Policy Freeze

The judgment to keep rates until Q2 2026 isn't based on optimism about the US economy, but on helplessness in facing four systemic risks. These form an "Impossible Quadrangle," where any rate adjustment risks triggering at least one crisis dimension:

First, rapid rate cuts could ignite a long-end Treasury premium crisis. Lowering rates compresses the yield differential between short and long maturities, reducing the relative return on long bonds, prompting institutions (pension funds, insurers) to reduce long-term holdings. Under sustained supply expansion, demand drops, causing long yields to spike—an inverse "rate cut—long yield rise" transmission. This was previewed in 2023 during the UK pension fund crisis; despite larger scale, the principle remains. Powell knows that aggressive easing could turn the Treasury into the biggest victim.

Second, too-slow cuts could worsen the hard landing of the labor market. Despite low unemployment, the quality of non-farm payrolls deteriorates—more part-time work, slowing wages, surging layoffs. The Fed's Q4 2023 monetary policy report admitted "marginal softening" in the labor market, a dovish signal causing bond panic—revealing further policy space contraction. Maintaining high rates amid weakening economy risks a repeat of late-Warwick Volcker tightening, risking a deep recession to stabilize inflation.

Third, fiscal runaway and monetary death spiral. The US needs to issue over $2.5 trillion of new debt in FY2024-2025 to cover deficits and rollover maturing debt. Higher rates increase interest payments as a GDP share, worsening fiscal sustainability; lower rates ease constraints, encouraging deficit expansion. Any Fed rate decision can be interpreted as fiscal support or complacency, fueling long-term inflation expectations. This "fiscal hijacking" reflects monetary policy failure.

Fourth, misalignment of global monetary cycles and capital flows. Major central banks are diverging: BOJ attempting to exit negative rates, ECB hesitating amid weak growth, RBA adopting "data-dependent" stance. Such divergence causes large USD rate swings through exchange rates, triggering cross-border capital flows, impacting emerging markets and reversing US financial conditions. The Fed must consider global financial stability, further constraining policy autonomy.

Historically, the Fed has adopted similar "policy freeze" strategies in three periods: early stagflation in the 1970s, mid-1990s productivity boom, and post-2008 long low-rate policy. Each freeze involved asset price volatility and sector divergence. The current fourfold pressure exceeds past examples in complexity and urgency.

4. Labor Market Weakening: The Final Variable Triggering Policy Deadlock

Among structural factors, labor market deterioration is the last straw pushing the Fed toward "lock-in" decisions. Saunders emphasizes Powell’s recent acknowledgment of a "softening" in the labor market, which triggers a chain reaction: bond markets, contrary to expectations of easing, see an expansion of term premiums. This counterintuitive phenomenon reveals a key mechanism:

As the "central nervous system" of the economy, labor market weakness conveys two conflicting signals: demand slowdown alleviates short-term inflation pressures, providing space for easing; but declining momentum heightens fears of long-term growth slowdown. Rigid fiscal expenditures mean that economic weakness forces increased borrowing, worsening debt sustainability. This split—"short-term positive, long-term negative"—intensifies yield curve steepening.

More challenging, labor market weakness carries asymmetric risks. With vacancy rates still above pre-pandemic levels, marginal demand declines could rapidly lead to nonlinear unemployment surges. The Fed is highly intolerant of such "hard landing" risks, balancing dual mandates: employment and inflation. Once clear recession signals emerge, policy choices become a dilemma: "Rate cuts could trigger bond sell-offs; no cuts could deepen recession." The optimal strategy is "wait-and-see"—avoid rate hikes that risk inflation rebound and avoid premature easing that fuels fiscal pressures, buying time for structural issues to soften naturally.

Madison's cautious phrase "gradual easing will slow down" disguises a deeper message: the Fed is no longer unwilling but unable. The limited toolkit, conflicting objectives, and complex external environment impose rigid constraints on policy.

5. Rebuilding the Investment Paradigm: Finding Certainty Anchors in the "Policy Vacuum"

With rates locked until 2026, traditional asset allocation frameworks based on central bank cycles will partially fail. Investors must realize that, over the next two years, the main drivers won't be FOMC statements but microstructural capital flows and macrostructural economic shifts. Specifically, six asset classes will face fundamental reevaluation:

1. Long-term bonds: high volatility and term premium risks. Supply-demand imbalances and credit risk reassessment will cause 10+ year UST prices to reflect fiscal sustainability rather than monetary policy expectations. Duration risk rises, reducing bonds' safe-haven attributes. Investors should shorten durations, increase sensitivity to credit spreads, or adopt steepening strategies for hedging.

2. USD exchange rate: structural high yields and fiscal risks tug-of-war. Rate lock benefits USD short-term interest differentials but fiscal fears weaken USD's reserve status. The dollar may enter a wide-range oscillation—lacking a clear depreciation catalyst nor a strong fundamental support. Cross-border investors will face increased hedge costs, impacting returns.

3. Gold and digital assets: non-sovereign value storage. As sovereignty credibility declines and fiscal overreach threatens currency purchasing power, gold and Bitcoin will garner systemic premiums. Unlike traditional commodities, these assets reflect inflation expectations and act as options on monetary stability. During rate lock, their correlation with risk assets may turn negative, becoming genuine diversifiers.

4. Tech stocks: valuation expansion to profit quality. Sticky long-term risk-free rates will end the "long-duration growth" valuation myth. Markets will shift from optimistic DCF discounting to strict scrutiny of current profitability and cash flow stability. Firms with pricing power, high margins, and controlled capex will outperform; speculative growth stocks relying on low-cost expansion face valuation compression.

5. Emerging markets: highly sensitive to global liquidity changes. Under USD rate high plateau and exchange rate volatility, EM assets will bifurcate: well-managed, low external debt economies attract safe-haven inflows; debt-dependent, high-deficit countries face capital outflows and currency depreciation. Overall volatility will rise beyond developed markets.

6. Crypto assets: leading indicators of liquidity shifts and risk amplification. Compared to traditional markets, cryptocurrencies are more sensitive to global liquidity changes, with prices reflecting marginal funding risk sentiment and speculation. During Fed policy uncertainty, leading cryptos like Bitcoin and Ethereum may lead lows or peaks, serving as "canaries in the coal mine" for risk appetite.

Conclusion: When tools run out, how will markets redefine pricing rules

Madison's analysis fundamentally exposes a troubling truth: the Fed's toolkit is nearing its effectiveness limit. Rate lock isn't a strategic choice but a passive defense amid mounting adversity. When the central bank signals "I have little room to maneuver; don't expect much from me," the power over asset prices shifts from policymakers to market participants.

From 2024 to 2026, the real story in global markets isn't the 25bp game of rate hikes or cuts but how markets will reprice risk assets amid fiscal chaos, structural imbalance, and credit overreach. In this process, certainty will become scarce, and "uncertainty itself" will be the greatest certainty. Investors must abandon habitual dependence on easing expectations and instead construct "post-monetary policy" portfolios centered on cash flow, credit quality, and non-sovereign hedges.

History shows that each collapse and reconstruction of monetary frameworks involves large wealth shifts. Those who understand the logic behind the "Rate Freeze" early and act decisively will likely seize the opportunity in this quiet revolution.