There's a popular story about the US central bank: it's trapped. It has to keep rates high to fight inflation, the story goes, while the government needs low rates to refinance its enormous debt pile affordably. An unsolvable contradiction.

The tension is real. But the picture is only half right — because the Fed has already resolved an important part of this bind. It simply separated its two tools. Miss that, and you draw the wrong conclusions from the situation.

What many still believe — and what actually happened

The common assumption is that the Fed keeps shrinking its balance sheet (quantitative tightening), draining liquidity from the system, raising the question of whether it can reduce the money supply without choking the economy.

That question has been answered. QT ended on December 1, 2025. Since the balance-sheet runoff began in June 2022, holdings had shrunk by more than $2.2 trillion — then it stopped.

More than that: since December 2025 the Fed has been buying securities again, specifically short-dated T-bills, through what it calls "reserve management purchases." As of June 10, 2026, the balance sheet was back to roughly $6.7 trillion — and inching higher. The Fed stresses this is technical, not stimulus. But the effect — more liquidity in the system — resembles QE, which is why some observers call it "stealth QE."

Why QT had to end: the liquidity floor

The ending came out of necessity, not generosity. In the repo markets — the short-term funding plumbing that holds the banking system together — strains appeared. Bank reserves fell to a merely "adequate" level, and short-term money-market rates drifted upward. It echoed the 2019 repo crisis.

So the opening question has a concrete answer: no, the Fed cannot reduce liquidity indefinitely. There's a hard floor — estimates place serious stress below roughly $2.5 to $2.7 trillion in reserves. The Fed hit that floor in late 2025. It found it, and stepped back.

The real resolution: two separate levers

This is the core the "dilemma" narrative misses. Since late 2025 the Fed has run two tools pointing in opposite directions:

• The policy rate stays restrictive — against inflation. On June 17, 2026, the Fed held the rate at 3.50%–3.75% for the fourth consecutive meeting, unanimously. More telling is the projection behind it: the median member now sees the end of 2026 at 3.8% — a reversal from March, when a cut was still implied. Translation: a hike is back on the table. The trigger is a supply shock — the Iran war and higher energy prices pushed the year-end inflation projection up to 3.6%.
• The balance sheet is neutral-to-slightly-expansionary — for market function. Not to stimulate, but to keep funding markets running.

Rate policy and liquidity policy therefore run on purpose in separate channels. That's the Fed's answer to the supposedly unsolvable problem: you don't have to pull both levers the same way.

What this means for Treasuries

The structural tension doesn't disappear — it just relocates. It sits with the Treasury department, not the central bank.

The Treasury's answer to high rates is to move to the short end: rather than issuing expensive long bonds, it funds itself increasingly with short-dated T-bills. Their share, at roughly 21.9%, now sits above the 15–20% range recommended by the Treasury's own advisory committee. That lowers average cost but raises rollover risk — a growing slice of the debt reprices frequently at short-term rates.

On the demand side the picture is mixed: solid overall, with bid-to-cover ratios in normal ranges — but more brittle. During the March escalation around Iran, auctions for 2-, 5- and 7-year paper drew weak demand, even though a 30-year auction shortly before had logged its strongest demand on record. The term premium — the extra compensation for holding long-dated bonds — has risen more over the past two-plus years than expected.

The real long-term risk

The biggest risk is no longer that QT chokes the economy — that chapter is closed. It's structural: the CBO and GAO project deficits averaging over $2 trillion a year through 2036 and describe the path as unsustainable. Rising debt at rising interest cost pushes yields up via higher term premia — regardless of what the Fed decides in the short run.

From this follows a mechanism market participants watch closely: if debt service and refinancing needs grow large enough, pressure builds — politically and practically — to keep rates lower than inflation actually warrants. The technical term is fiscal dominance. It isn't a present condition but a scenario whose probability rises with the debt load.

A methodical bottom line

Let's separate what we know from what is interpretation.

Documented and measurable: QT ended on December 1, 2025. The Fed has been buying T-bills again since December. There's a liquidity floor, and it was reached. The policy rate is restrictive, and the dot plot implies a possible hike. The Treasury is heavily bill-funded. Deficit projections are large.

Interpretation and open: Whether the September hike arrives depends almost entirely on the oil-and-Iran factor — if that eases, it's quickly off the table. Whether and when fiscal dominance moves from scenario to reality is speculation.

And honesty requires this: it's not a crisis call. The market functions, demand is broadly there, the buyback program supports liquidity. But the margin of safety has thinned — and elevated volatility at the long end is likely the new normal.

This post is an analytical read, not investment advice. Study the Past — Improve your Future. 🥋