Bessent’s Bond Battles: A Crisis of Credibility in the Treasury Market

Treasury Secretary Scott Bessent’s recent efforts to quell liquidity problems in the government debt market have fallen short, leaving markets skeptical and wary. His two-pronged approach – accelerated buybacks and attempts to talk down yields – has met with limited success.

The Treasury’s decision to double its bond buybacks starting in early September initially sent yields tumbling, but this relief was short-lived as market experts expressed skepticism about the plan’s chances of success. Bessent’s subsequent appearance on CNBC, where he assured investors that the intervention aimed at providing market liquidity rather than controlling the yield curve, had a minimal impact on market pressures.

Critics argue that the buyback announcement itself was improper, breaking with Treasury’s long-held strategy of making regular and predictable announcements. Jefferies’ chief U.S. economist, Thomas Simons, notes that this departure from precedent reduces the overall credibility of Treasury’s guidance. Moreover, the sloppy wording of the headline on the release gave the impression that the decision was hastily made.

Bessent faces a challenge in suppressing longer-end yields without giving investors another reason to demand more compensation. This is particularly concerning given rising competition from corporate bond issuance and attractive yields on other sovereigns like Japan. Additionally, market developments are compounded by a correlation with oil prices that increases inflation fears and term premiums.

One possible solution for Bessent could be cooperation with the Federal Reserve. While Fed Chairman Kevin Warsh has emphasized the importance of letting the market set rates, Bessent suggested Thursday that the two entities would work together in dealing with complications in the bond markets and managing their respective Treasury holdings.

However, this cooperation is not without its risks. The various moving parts in play come during a paradigm shift in the government debt markets, both domestically and globally. As Atsi Sheth, chief credit officer at Moody’s Ratings, notes, there has been a structural shift in who buys U.S. government debt. With central banks shrinking their balance sheets and traditional duration buyers reaching the limits of how much additional issuance they can absorb, new buyers such as leveraged hedge funds running relative-value strategies are taking center stage.

This raises questions about the long-term sustainability of Bessent’s plans. Can he effectively manage market expectations without sacrificing credibility? Will his efforts to suppress yields merely drive up demand for compensation from investors? The answers to these questions will be crucial in determining the success or failure of his bond battles.

Bessent has a few options at his disposal, none of which are guaranteed to work and each carrying its own risk. He could opt for bigger and more frequent buybacks, smaller auctions, or change the maturity composition of outstanding debt. Alternatively, he could invoke what is being dubbed the ‘Bessent put’, using his tools in an unpredictable manner to keep investors off guard.

Whatever route Bessent chooses, his credibility will be on the line. Markets are already growing skeptical and leery of the challenges Treasurys face, and a misstep could have far-reaching consequences for the entire market. The Treasury chief must walk a fine line between reassuring investors and addressing the fundamental issues driving yields higher.

In navigating these complexities, Bessent’s bond battles will be a test of his ability to manage market expectations without sacrificing credibility. The outcome will have significant implications not just for the U.S. economy but also for the global financial landscape as a whole.