The Bond Market Just Called Bessent’s Bluff

Well, the bond market is collapsing and it looks like Treasury Secretary Bessant has completely lost control of treasury yields. We're seeing yields across the curve surge over the last couple of weeks, from the 30-year, the 20-year, the 10-year, the 2-year, and the 1-year. And we know that yields move the opposite way the bond prices do, so when yields are skyrocketing, that means that bonds are getting dumped, they're getting sold off, and the prices of the bonds are And this comes despite the fact that Scott Bessant has been intervening in the treasury market by increasing buybacks to try and stop yields from rising. Just a couple of weeks ago, Scott Bessant announced that he was going to be increasing the size of treasury buybacks at the long end in order to stop yields from rising. But as you can see, that did basically nothing and yields have just continued to go up. And it wasn't just the increase in buybacks from a couple of weeks ago, it actually increased again once the buybacks came around. What started as $2 billion and then increased to $4 billion ended up being $6 billion of buybacks. However, that's facing a $32 trillion debt market. If you go to fiscaldata.treasury.gov, you can see the treasury securities buyback schedule and you can see what has been recently announced. And you can see that as of September 10th, the buyback that was announced was $6 billion. On this report, you can see the maturity dates that are being purchased back. And interestingly, which we'll talk about in a moment, you can see the interest rate that was getting paid on those bonds that they are buying back to retire. Looking at the maturity dates of what is being bought back, you can see they're all about 15 to 20 years until maturity. Now, it's also interesting that you can see on September 9th, just a day before, there was a $12.5 billion buyback that was announced. And you can see the maturity date on these is all relatively soon. This is debt that matures in one to two years. Now, what you'll notice is the interest rate that the US government has to pay on this debt that's getting bought back and retired, the interest rates are all pretty low. And that's especially true of the long-term debt that is getting bought back. You can see the coupon rate 1%, 1%, 2%, 1%, 2%, 2%, 2%. And yeah, some of it is higher, like this one is 5%, but a lot of it 2.8%, 3%, 2.5%, 2.5%, 2.5%. So this is not due to the fact that the United States government is saving money by buying back this debt. It's the exact opposite. This is like using a credit card with a variable interest rate that changes every month, but you're currently paying 3% to 5% on and paying down some of your mortgage debt that's not due for another 30 years that has a very low interest rate, like 2% or 3%. You're intentionally increasing your debt costs by doing this. And so the purpose of these buybacks is not to lower the interest cost on the debt that the government is paying right now. The purpose of this is to try and stop bonds from getting sold off because the 10, 20, 30 year, they're all getting sold off right now. But the amount of buybacks that the treasury can do by itself is just not sufficient for the overwhelming size of the bond market. And that's why, despite the fact that the buybacks have been increased so drastically lately, those bonds are still getting sold off way more than what the treasury is buying back, causing yields to skyrocket. Part of the reason for this is because oil has been surging. You can see that the price of oil is back up to the point where it was at, kind of at the height of the fears of the war with Iran back from March to May of this year. And that has directly contributed to the recent inflation numbers that came in much hotter than expected. If you are a lender, which is a bond buyer is a lender to the U.S. government, then you are going to demand a higher interest rate if inflation goes higher. Let's say to keep numbers simple, you know inflation over the next 30 years is going to be 5%. Well, you're not going to lend somebody money at 5% because you know that your actual return when you get your money back is going to be zero. And so just in case inflation is a little bit higher than that, you're going to demand a higher interest rate to make sure that the devaluation of your purchasing power is covered. And so as inflation concerns and oil prices go up, bond investors are demanding a higher interest rate. 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And it's been a very long time since the United States government has had to issue new debt at prices that were this expensive. If you look at 30 year treasuries, you have to go all the way back to May of 2004 until you see 30 year treasuries trading at this level. And even then they only briefly touched it. You have to go all the way back to 2001, 2002 to see a time period in which they were trading around here regularly. And it's the same thing with the 10 year as well. We are approaching 5% yields on the 10 year treasury. We have to go all the way back to 2006 and 2007 before we find the time in which the 10 year was trading at these levels. Now, it's a little bit funny that this is happening right now, especially the last couple of days, because Scott Besant has recently been going around saying things that indicate he's in control of the bond market. In fact, when he was talking about his intervention with the yen, he literally said, I am the house now. He said, you can try to bet against me, but I am the house. I'm acting with asymmetric insider information. So good luck trying to play against me. And the bond market is right now calling his bluff. The bond market is selling off despite the fact that he's saying, hey, I'm not going to let yields go higher. But looks like as of right now, the treasury just doesn't have the firepower needed in order to stop this from happening. And the reason for this is because the treasury by itself cannot issue new currency. They can't print money. The only way they can buy debt off of the market is by issuing new debt. Now, it is true that the treasury has something called the treasury general account. You can think of this just like their checking account. And right now they've got close to a trillion dollars in their checking account. But you can see this account regularly dips down pretty dramatically close to zero every single time there's a government shutdown. And so the treasury likes to have about a trillion dollars in this checking account of theirs because when the government shuts down and they have to keep on paying for the things that they have to pay for, but they cannot at that time borrow new money, they want to have a checking account full of a rainy day fund so that they can last the time that takes Congress to get their act together. So Besant has implied he's willing to drain the treasury general account in order to buy back as many bonds as are necessary to suppress yields. But again, that's still just a short-term game that cannot last forever. And even if he's willing to spend $800 billion out of the treasury general account, that's still a drop in the bucket against a $32 trillion treasury market. The bond market simply has much more firepower than what the treasury can absorb. So this is where a lot of people think the Federal Reserve is going to come in because historically the Federal Reserve has stepped in to do quantitative easing during times like this. But Kevin Warsh, who is now in control of the Fed, has explicitly stated many times that he doesn't want to just do QE and he doesn't want the Fed to be stepping in and just buying bonds in a normal market. He says that's reserved for some sort of economic crisis. And so the small amount of QE the Fed is doing right now is reserved to T-bills and shorter term debt, which is really kind of the exact opposite of what the United States Treasury really needs some big buyer to come in and buy. There is demand at the short end of the curve. There's really no demand at the long end. That's why the treasury is stepping in and buying that debt off of the long end. And so Scott Besant is engaging in what he's calling the treasury twist right now, which is essentially shifting a lot of that longer maturity debt over to the short end. He's trying to buy back at the long end, but he's borrowing at the short end in order to do that. He's shrinking the average maturity of the national debt. And this is called treasury twist because the Federal Reserve has done something called an operation twist in the past where they realign the composition of their balance sheet to more accurately represent the outstanding treasury debt. For example, if they had all T-bills on their balance sheet, but the United States government has borrowed a lot at the long end, maybe they would sell some of their T-bills and buy up some of the long end. Unfortunately, the Federal Reserve cannot do something like that right now. Right now on the Fed's balance sheet, they have about four and a half trillion dollars worth of US treasuries held on their balance sheet. And if you take a look at this chart, you can see the breakdown in maturities where you can see the most that they own is debt that matures in over 10 years. And then the next category down is debt that matures in one to five years. Next category down from there is debt that matures between one and five years. And then below that is between five to 10 years. And this chart shows the average maturity distribution of United States government outstanding debt. This goes back to 2000, but you can see right now the vast majority of the maturity distribution of the government debt matures in under five years. It's about 70%. So if you want to compare these apples to apples, you can take a look at these pie charts and you can see that the Federal Reserve on their balance sheet holds about four and a half trillion dollars worth of treasuries versus about 32 trillion dollars in outstanding treasury debt on the market. Of the Fed's treasury holdings, about 2% of it will mature within 15 days. That's compared to 4.7% of all marketable treasury debt. You can see the Fed holds about 8.8% that matures within 16 to 90 days versus all marketable treasury debt. That number is 14%. You can see the three months to one year category, the Fed holds about 11% of that on their balance sheet versus the US government has about 14.8% outstanding. You can see the one to five year category makes up about 31% of the Fed's balance sheet versus that same category makes about 35% of all marketable debt. You can see the five to 10 year treasury category is about 10.4% on the Fed's balance sheet versus about 13.3% of all marketable treasury debt. And you can see that the over 10 year category is about 35% of the Fed's holdings versus about 18% of all marketable treasury debt. When you compare these two side by side, you see the Federal Reserve owns a smaller relative chunk of all of the shorter maturities and they own a much larger chunk of the longer dated treasuries. Anything under 10 years, maturing in 10 years or less, the Fed owns a much smaller chunk of that relative to what is outstanding on the market. Anything over 10 years, the Fed actually owns a much larger percentage of that compared to outstanding debt, which means the Federal Reserve cannot maintain a neutral balance sheet and help the treasury out with this problem. If the Fed owned treasuries with each maturity basket roughly matching what is outstanding on the open treasury market, they would have to sell off a bunch of their long term treasuries and buy up more at the short end. Again, that's the opposite of what the needs right now because everyone is dumping the long end. So right now, the biggest buyer of long dated treasuries is the treasury itself. Now, at this point, I start to see questions come up like, what is the plan here? It seems like the actions that are being taken are so ineffective at accomplishing the stated goal that people start to think there must be some different goal. There must be some secret plan. They must be playing 3D, 4D, 5D chess. And unfortunately, I don't think any of that is true. Long term treasury yields are just a direct reflection of the market's anticipation of growth versus inflation. That's it. And so the two biggest actions by the government over the last couple of years that have the largest impact on growth and inflation are tariffs and the war. If government spending would just significantly go down, then growth expectations would go up and inflation expectations would go down, yields could collapse. The treasury would get exactly what it wants. But it's fighting against executive and congressional action that is directly at odds with what it wants. And the only way for both short term and long term interest rates to come meaningfully down is either to have it be done by the free market, in which you need growth expectations up and inflation expectations down, or you need a new buyer to come in and just buy up all of that debt anyway, which historically has been the Fed. But with the new leadership at the Fed, that seems unlikely unless directly commanded to do so by the treasury or by Congress. Now, I've talked before for a long time about bank deregulation, getting rid of the supplementary leverage ratio, and that takes time for something like that to be done permanently. And so with yields skyrocketing at the long end right now, we just don't have the time to wait for something like that to happen. So what we could see is a temporary emergency suspension, another thing that happened in 2020 to 2021, where it's temporarily suspended for a year, two years, or even if they say indefinitely, just don't attach a deadline to it yet. But really, this is just a big, hairy, complicated, and hard-to-solve problem. We're unlikely to get meaningful bank deregulation in a short amount of time. We're unlikely to see the market just turn around and just start buying up treasuries. We're unlikely to see inflation turn around anytime soon. We're unlikely to see the Federal Reserve just change their mind and start to increase QE across the curve again. And so it does look like yields are going to continue to go up, at least for the foreseeable future, because buybacks, the treasury alone, cannot influence this enough. They don't have the firepower. Now, there are a couple other small drops in the bucket that we could see happen in order to try and solve this problem. Number one, it's possible that people start floating the idea of ending the Federal Reserve's ability to pay interest on reserve balances held at the Fed. Right now, banks hold trillions of dollars of their reserves at the Federal Reserve and they get paid an interest rate on that. If the Fed is banned or no longer allowed to pay interest on overnight reserves held at the Fed, then all that money would leave and be invested in T-bills instead. And so we'd see significant demand for T-bills, which would shove the low end really, really far down and potentially allow the U.S. government to temporarily just suspend all borrowing at the long end, roll everything over into the short end because there's enough demand to do so, and then kick that can down the road and wait to solve that problem of that debt maturing every single year or two years. We'll solve that problem a year or two down the road. We'd also see direct intervention and a changing of who controls what the Federal Reserve does with their balance sheet because they've stated more and more about how their monetary policy and the thing that they are independent in is most focused at controlling short-term interest rates. And so if Congress or the Treasury directs the Fed outright to say, hey, you need to expand your balance sheet, I don't know, that might be something that we could see. But either way, what's going on right now with yields across the curve from the short end all the way to the long end is really not pretty. Nobody likes this. And the higher they go, the more it hinders growth. At the same time, though, the higher they go, the more likely it is we see some emergency action because they're desperate and they need to force yields to go lower. One last note, if you're an active investor and your portfolio is not growing as fast as you'd like, my team and I put together a completely free gift for you. 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