On August 22nd, Markets Weekly highlighted the U.S. Treasury's unexpected intervention in bond markets, as Secretary Besant addresses relentlessly rising long-bond yields, currently at 5.3%. This surge, reaching levels not seen since before the 2008 financial crisis, is deemed "historically high" and unacceptable by the Treasury.
Several factors contribute to these rising yields: a global movement driven by the Iran war and escalating energy prices, concerns about the Federal Reserve's commitment to its inflation targets (especially following recent ambiguous statements from "Kevin"), and market dynamics like hyperscalers crowding out Treasuries or a strong equity market making 5% bond yields appear unattractive.
In response, the Treasury last week made an "extraordinary" and unscheduled announcement to upsize its buyback program in the long-end sector. This program, initially introduced by the previous administration, had two primary aims: cash management (deploying excess cash from lumpy tax inflows) and, more importantly, liquidity management. The Treasury market is complex, with each issuance having a unique identifier (QSIP). Newly issued "on-the-run" Treasuries are very liquid, while older "off-the-run" issues become progressively illiquid. The buyback program aimed to improve this by allowing the Treasury to act as a "dealer of last resort," buying back illiquid off-the-run securities, thus encouraging primary dealers to make markets in them. The prior administration emphasized that this was duration-neutral, financing buybacks by issuing more of the same duration.
However, Secretary Besant has explicitly called the current action a "Treasury Twist," signaling a significant shift. Unlike the original program, Besant intends to issue short-term bills to buy back long-term bonds, thereby shortening the overall duration of outstanding Treasury debt. This is analogous to the Fed's "Operation Twist" in 2012, which aimed to put downward pressure on long-dated rates. While the initial market reaction saw long bond yields drop by about nine basis points, this was quickly reversed, partly due to rising oil prices. The speaker believes, however, that the Treasury possesses ample "firepower" to make this strategy effective.
Beyond simply upscaling the current buyback program, the Treasury has a broad toolkit for further intervention:
1. **Cutting Issuance Sizes:** The Treasury could directly reduce the supply of new long-end bonds, a strategy recently employed by Japan for its 40-year bonds, which led to a notable (though temporary) impact on yields.
2. **Encouraging Banks to Buy:** Leveraging its regulatory power, the U.S. government could pressure commercial banks (e.g., during merger approvals or by adjusting capital requirements) to increase their Treasury holdings, framing it as a "patriotic" duty.
3. **Utilizing Government-Sponsored Enterprises (GSEs):** Entities like Fannie Mae and Freddie Mac could be directed to purchase Treasury bonds, similar to how they were commanded to buy mortgage bonds in the past to lower interest rates.
4. **Fed Involvement (The Nuclear Option):** The ultimate tool is "yield curve control" (YCC), where the Federal Reserve actively caps long-term yields. This was done in the U.S. in the 1940s and more recently by Japan. The Fed's third mandate—"moderate long-term interest rates"—could provide the political justification for such an extreme measure, though it would likely have implications for the currency.
In conclusion, the speaker asserts that 5.3% is an unacceptable level for long-bond yields in the eyes of the Treasury, and they are fully committed to bringing them down. With a comprehensive toolkit at their disposal, they are confident in their ability to manage the situation, though a resolution to the Iran war would be the "best thing" for a sustained reduction in yields. The market is set to test the Treasury Secretary's resolve in the coming weeks.