Scott Bessent’s Announcement Could Twist His Credibility

Strategist Ed Yardeni coined the phrase “bond vigilantes” in 1983. It describes the bond market investors who sell government bonds to drive yields higher as a protest against inflationary government policy.

Recently, we’ve watched these vigilantes emerge not only in the U.S. but in several places around the globe (Japan, France, and Germany). The 30-year U.S. Treasury yield surged to 5.33% last Wednesday, hitting its highest level in 19 years. 

That same day, the U.S. national debt crossed a remarkable $40 trillion. To put that into perspective, the U.S. now spends $1.1 trillion annually to service its debt via interest payments, more than its entire national defence budget.

Operation Twist to Financially Engineer Treasury Yields

Over the next two days, U.S. Treasury Secretary Scott Bessent announced plans to “twist the yield curve” by issuing short-term debt and using those proceeds to purchase about $4 billion worth of long-term bonds between September 9 and November 4. 

Bond prices move inversely to their respective yields. Like a seesaw, when one goes up, the other goes down. The objective here is to buy long-term Treasuries, driving up the price, which will then bring down the yield on the 10- and 30-year Treasury, which are directly linked to mortgage rates and car loans.

While $4 billion thrown at the long-term U.S. Treasury market sounds fairly powerful, keep in mind that long-dated Treasuries are almost a $10 trillion market. Nevertheless, the pronouncement alone from Bessent may have the effect he’s hoping for to lower long-term rates.

With the cost of borrowing rising, surely the U.S. midterm elections are top of mind.

Bessent has credibility as one of the few adults in the room. Every time he speaks, the market listens. But if this plan doesn’t succeed in curtailing long-term interest rates, that well-deserved reputation is likely to weaken.

Undermining New Fed Chair Kevin Warsh

Less than 14 weeks on the job, the new U.S. Federal Reserve Chair Kevin Warsh now has a full plate of problems on his hands. Not only is he tackling stubborn inflation above the Fed’s 2% target with a divided committee, the Treasury Secretary is publicly undermining him.

Warsh remains tight-lipped about the Fed’s next move, and internal friction is mounting. He has one vote among 12 members, and three voted to hike the short-term Federal Funds Rate at the last July policy meeting.

Inflation is running at 3.3% and has been running above the Fed’s 2.0% target since April 2021 (5 years and 4 months). 

If Warsh and the Fed are trying to keep financial conditions tight to quell inflation, having the Treasury Department step in to financially engineer the yield curve two months before the midterm elections clearly undermines their efforts. 

Scott Bessent has been a credible voice to the market. It would be a shame to see it frittered away.

(Disclosure: Our clients do not own any U.S. government bonds. Instead, we presently look to Canadian preferred shares that yield over 5% to provide suitable clients with income.)

-written by Jeff Pollock