Key Highlights

• Powell’s video response decries DOJ “pretexts” as a threat to Fed independence
• Congressional reaction is lining up against the move
• T-bill supply in 2026 will depend on spending plans, which could exacerbate funding stress

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DOJ probe leads to congressional resistance

EXHIBIT #1: UST RISK PREMIA COULD RISE FURTHER, TAKING YIELDS WITH THEM

_{Source: BNY Markets, Bloomberg, Federal Reserve Bank of New York}

This past Sunday, Federal Reserve Chair Jerome Powell posted a video in which he revealed that the Department of Justice (DOJ) had served the Fed with grand jury subpoenas. The subpoenas relate to Powell’s testimony to the Senate Banking Committee about the renovation of the Fed’s Washington, D.C. headquarters, long a point of criticism by the administration. Powell referred to the investigation as “pretexts” to weaken and diminish the Fed’s ability to set monetary policy independent of pressure from the executive branch. This opens a new, more fraught chapter in the administration’s attempt to assert ever more authority over the Fed.

As of this writing, the market’s reaction has been directionally equivalent to what would have been expected, with the dollar weaker, bond yields higher, and equities lackluster, although the size of the movements has been muted. It could be that challenges to Fed independence are already well-incorporated into market expectations. Furthermore, retiring North Carolina Republican Senator Tom Tillis of the Senate Banking Committee has pledged he will vote against any future Fed appointments – which must pass through the Committee’s process before going to the entire body for approval – until the matter is “fully resolved.” With the partisan split on the Committee favoring Republicans by just 13 votes to 11, Tillis’s position would essentially freeze all nominations to the Fed’s Board of Governors. Governor Stephen Miran’s term is scheduled to end on January 31. It was expected that his replacement would ascend to the chair’s seat upon the expiration of Powell’s term at the end of May. Recall, the administration’s effort to remove Governor Lisa Cook from the Fed Board for cause will be heard by the Supreme Court on January 21.

Despite the market’s somewhat subdued initial reaction on Monday, we caution that risk premia could rise if the situation is prolonged or gets messier. Exhibit #1 shows that the term premium on the 10y note has been creeping higher since mid-October but remains just below its 2025 lows. On a longer-term comparison, the currently observed 80bp of premium is among the highest levels seen in the past decade. However, it could rise further if the central bank’s independence and credibility were seen ebbing.

We will be watching for the Senate reaction – especially from the members of the Banking Committee. Since Tillis is an outgoing senator, watch for comments from other legislators – particularly Republican members who are not retiring. Also keep an eye on the USD and fixed income markets for signals of how the market is digesting this development.

As for monetary policy, we expect little change around the FOMC’s rates outlook in the short term; market pricing for 2026 was only slightly different (in a marginally more hawkish direction) on Monday. The Committee makeup is intact for January, although the fate of Miran’s seat on the board could be undetermined indefinitely if Tillis’s threat to gum up the confirmation process is carried out. 

2026 bill issuance uncertain; tariff decision, dividend checks still in question

EXHIBIT #2: BILL SUPPLY SET TO RESUME

_{Source: BNY Markets, Bloomberg, U.S. Treasury}

In 2025, net T-bill issuance from the U.S. Treasury was around $350bn, but as Exhibit #2 shows, this final accounting masks significant variability across the year. Starting in early 2025, the U.S. debt ceiling was reached, impeding further issuance from Washington. By the end of June, year-to-date issuance totaled –$400bn. It rebounded sharply after the Republican spending bill passed in early July – in fact, by the first week of November, net bill supply had rocketed by $938bn since the budget bill was enacted.

The size of the Treasury General Account (TGA) has been fluctuating between $800bn to $900bn in recent months, and the Treasury consistently targeted an average of about $850bn. What’s not clear is how much bill issuance will be necessary in the first half of 2026. New quarterly funding statements are due in early February, and we don’t expect significant changes to coupon supply compared to the previous quarter’s auction.

This implies that incremental government funding will come from front-end issuance. The size and scope of that issuance will depend on the administration’s spending plans and the Supreme Court’s pending decision on the IEEPA tariffs, expected as early as this week. An unfavorable decision for the administration would open a funding gap of around $150bn to $175bn. There have also been frequent hints of a “dividend” check of $2,000 for U.S. taxpayers, though the details remain unclear. Additionally, higher tax refunds are likely, thanks to provisions in the budget bill.

Meaningful increases in bill issuance could strain funding markets, which struggled in late 2025 as system reserves fell from abundant to merely ample – prompting the Fed to curtail quantitative tightening and later introduce reserve management purchases (RMPs). If fiscal authorities again turn to T-bill issuance at a 2025-like scale, we could see these pressures return, potentially prompting more aggressive RMPs from the Fed this year.

Rates outlook

Last week’s December employment data was mixed, with a surprise decline in the unemployment rate (from 4.6% to 4.4%), although the number of new positions created was below consensus expectations (50k versus 70k). Job creation was narrow and concentrated in only a few, mainly noncyclical, industries.

Market expectations haven’t moved much in the wake of the jobs report, nor has the latest news of the Department of Justice probe into the Fed. We stick with the likelihood of three cuts for 2026, with the first one not likely until at least the March FOMC.

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