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Has the U.S. Treasury started financial repression? | Topical Thoughts
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What happens when the bond market starts pushing back?
The U.S. Treasury has made an unusual move: doubling long-end bond buybacks to contain rising long-term yields. But the bigger story is not the buybacks themselves but what they signal.
As debt burdens rise and fiscal risks move center stage, the key question becomes:
Can debt management substitute for fiscal discipline?
Welcome to another in our topical thought series, which we've titled here Let's Twist Again. Now I'm joined by Tom Leby. Tom, let's twist again. Is this a new dance that you're thinking about? Or what do we mean by let's twist again?
SPEAKER_01Well, first of all, of course, yes, I considered uh about the new dance, but no, it's it's referring to the old um Operation Twist. Remember, where back in the old days that the Fed tried to manage uh maturities by putting a lid on longer-term treasuries while obviously letting more room for short-term treasuries. And now, as we've seen over the past few days, the US Treasury with uh Scott Bessent is trying to do exactly the same. That's where the name comes from. Let's twist again.
SPEAKER_00I mean, of course, I mean the focus right now is on what's happening in the US, the US economy, and about interest rates. We know that President Trump has been very keen to get interest rates down as low as he can do. He's been putting a lot of pressure on the Federal Reserve over that period. Uh, and yet now we've seen the Treasury intervene. We've had Scott Bessant say in the past that he wants to see long rates, long bond yields come down because he feels that's the the the main part for the economy in terms of uh allowing lending to flow and allowing companies, households, and of course the government itself to finance at lower rates. So were you surprised by this intervention? Um it seemed to catch some by surprise. And does it really show that we've reached a pain point in terms of the level that bond yields can go to?
SPEAKER_01Look, quite clearly many actors in the economy would prefer lower interest rates because uh it lowers your financial. Who wouldn't, right? Exactly, who wouldn't? Households, companies, the government. But as we all know, in in in a market economy, that's not it's not only it's not always what you wish for. Obviously, we have uh uh a large number of pr players balancing out uh supply, demand, different interests and drives. So clearly um there there was a signal coming from from investors, from markets that uh they're not willing to buy uh particularly longer-term treasuries at the price that we have seen over the past few years, which means uh vice versa, interest rates have been going up. And yes, I would say the actual move was somewhat surprising uh because it came just two weeks after the Treasury did announce, as they usually do, their quarterly report, the quarterly uh uh buyback process, because they have been doing this before. It's not out of the blue. They have been buying longer-term treasuries while issuing more short-term treasuries. But the announcement coming out just two weeks after the regular announcement was a bit of a surprise indeed.
SPEAKER_00Now, just for our listeners, I mean, when we think about your interest rates and we think about your managing the economy, we we generally think about the central banks. Uh, we think about the central banks looking at inflation and managing their interest rates and their policy rates according to the inflation and their inflation target. Now, that's where a lot of focus has been in the in the US as well, around the the Federal Reserve, the independence, meaning that they would act beyond any kind of political pressures based on the facts that they're seeing, the data they're seeing in order to hit their inflation targets. Maybe explain a little bit about what's different because we're not talking about the Fed here. We're now talking about the US Treasury, which is not independent, of course, it's part of the US government.
SPEAKER_01No, as as you alluded to, normally uh central banks are responsible to set the price of money in the short term, meaning they set um overnight rates or short-term rates uh in in in in many regions and countries, and they let markets decide the the the correct level or the the perceived correct level of long-term rates uh based on, well setting maybe the short-term rate, but also on the needs, demand, supply, the growth rate, inflation expectations, uh long-term premium. There's many, many aspects that play into uh the the eventual outcome of how high long-term yields should be. But obviously, long-term government bond yields are basically the price a government has to pay to investors to borrow from them, to borrow money. Now, as we just said in the beginning, everybody or most people actually would love uh lower rates because that means they can uh borrow uh at a cheaper rate. Um so even the Fed normally does not directly intervene in the long-term treasury market. Now, it happened to be the case, they did so back in the old days, as I said, during Operation Trace. But usually that is not necessary because they think yields are simply too high, but because they might be worried about the financial structure, about the health, about the proper functioning of the markets, which currently I would argue is not the case. Because higher treasury yields are simply uh uh uh an outcome of of several aspects. We had m maybe some inflation worries with regard to higher oil prices triggered by the conflict in the Middle East. We had obvious a bit of uh more competition, if not crowding out with regard to to uh looking for finances because we have we are in the middle of an AI boom, there's a lot of CapEx spending, more and more companies also raise money, so that also sucks out liquidity to some degree. Uh we also had a Fed which kind of turned a little bit more vague and they they they they they are more reluctant to be able to do that. No more forward guidance. No more forward guidance, which adds another layer of uncertainty, which also uh has a has an implication, meaning investors are less certain about the path forward, they're less uh certain about where inflation goes, where interesting, and they also ask for a higher premium to hold long-term problems. So bringing everything together, this is then uh the result, uh, or or the result will be the long-term yields. But of course, as a government, you would prefer these yields to be lower. Now you could either start to to to to to to address the cause, all these worries, inflation expectations, risk premium, the fiscal deficit, uh, so on and so forth, or you can fight the symptoms and try to uh to to to put a lid on longer-term treasuries uh by means of financial engineering. And that's exactly what's happening now.
SPEAKER_00So so so tell me, I mean, what we were saying really is that it's market forces, supply and demand that drives the long end of the curve, right? As opposed to policy rates. Um and all the things that you've mentioned, you know, we've seen uh 30-year treasuries, I mean, they broke out from the kind of 5% level, they got up to about 5.30 before this kind of intervention set in. We've seen 10-year treasuries be more, I guess, well behaved, staying within the range that they've been in for the last three years. But the things that you mentioned that have driven these long end of the curves higher, is this a global phenomenon? Because we have seen other bond markets move, or is this just specific to the United States?
SPEAKER_01No, it's quite clearly also a global phenomenon, but it's quite difficult to disentangle because obviously markets, global markets are very very linked together, they're highly liquid. So if there's uh one trigger, let's say in the US, uh that will also have a spillover effect to other markets. And we all know what happened in Japan. Obviously, even their 30-year yields have uh recently risen quite dramatically, have hit uh new highs, which means also some of the money that maybe was was invested in the US or in the UK or in Germany for that matter, uh will be brought back down uh back to Japan because higher yields there also are attractive. So you see the link between markets clearly leads to all these spillover effects. So I wouldn't say it's a purely US phenomenon. It's clearly also happening in other regions. Japan is a good example, but kind of as a at at a margin or basic as a result, we also see higher yields in in the Eurozone, we see higher yields in the UK. So clearly you cannot isolate one single region in a global market.
SPEAKER_00Now, I would say there's a commonality in a lot of these regions, which is you know debt levels are very high and growing, and deficits are are wide and in many cases also widening. Um the US has seen its debt load rise significantly. They've been running a large deficit, which is unusual because if I think about the US economy, I mean nominal growth. I mean, looking at the growth dynamic plus inflation is what five or six percent. So isn't it unusual to have a kind of a growth dynamic as good as that, and yet we've got a definite deficit that's what, five or six percent?
SPEAKER_01Absolutely, that is unusual. And you can also show it, I mean, if you just look at, for example, a chart that shows unemployment rate and the fiscal deficit, you can see a very strong correlation over the business cycle, which makes sense. I mean, if you if you think about it. A government usually tries to to balance out the business cycle. So whenever uh the economy is is is suffering, maybe we're in a recession, meaning uh first of all, more people are unemployed, they they receive social support and social benefits, while at the same time fewer people pay pay taxes. So the revenue, the government's revenue will will shrink, which means by design or kind of automatically the budget deficit rises. While during good times you have the opposite. So you have fewer people uh receive social support uh while more people pay taxes. So that those are the times, those are the periods where a government should actually spend less, leave it to the private economy, to households, to companies, just to be there and to be ready when the next recession hits, because it will hit at some point for sure. Now that system or that correlation broke down a couple of years ago and it never came back. Obviously, it got worse during COVID, and which is understandable. Governments globally did really open the purses and and they spend and support the economy, which made sense at the time. But in many cases, these budgets were never really brought back to the normal level, and the US is a prime example there with five, six percent fiscal deficit in a time where the economy is growing at two percent real, five percent nominal. That is highly unusual.
SPEAKER_00Trevor Burrus, Jr. Now what we said earlier, and uh I feel strongly, is that this isn't just a US problem. There are there are many countries, there are many governments who really need to not just talk about bringing debt and deficits down, but actually doing something about it. Um but as you said, the US is doing something about it, but it's perhaps about the uh the impact that it's having rather than the cause of that. So, how successful is this going to be? I mean, market players are quite smart. They know that if they're intervening at these levels, won't investors continue to challenge or push these levels just to see how strong that resolve actually is?
SPEAKER_01Well, look quite clearly, history tells us that markets, and in particular the bond market, has a tendency to test politicians' resolve. So whenever a government globally has made an announcement, be that to defend a currency or a yield level or anything, usually markets try to test this and and and try to put pressure maybe on on the willingness uh to defend this line in the sand. Now we have to maybe bring the numbers together. Now the announcement, first of all, they haven't really done anything. They announced that they want to double, at least double, the buyback of long-term treasuries as of uh beginning of September. So they haven't really done that yet. And even the announcement in itself, um, they announced like um they want to double the buybacks from $2 billion to $4 billion per operation. We have roughly two operations, one in the 10-year segment, one in the third-year segment. So we talk about maybe $4 billion a month, roughly, that they would buy more. That's that's not uh an awful amount of money compared to a $40 trillion debt pile and uh a lot, a lot of uh more issues. However, the signal is very strong. First of all, they could do more. I mean, technically, and that's also what is debated right now, they could use funds from the Treasury General's account, which is almost one trillion dollar. Um and at some point, and that will be the crucial question, um, would the Fed actually go along? Because one crucial point is by putting a lid on longer-term treasuries, they kind of implicitly or even explicitly loosen financial conditions. And remember, we are in an environment where the Fed is worried about uh financial conditions. They are worried about inflation, they're worried about the oil price, and they leaned towards a more hawkish stance recently. So you see this kind of contradiction, let's call it. I mean, the Treasury trying to loosen financial conditions and the Fed leaning towards tighter conditions. It will be very interesting, very crucial how this uh this contradiction will pan out.
SPEAKER_00Now, thinking about contradictions, the one that I'm a bit baffled by as well. We have a relatively new Fed chair who doesn't really want to communicate very much. He doesn't want to spoon feed the markets. He's saying, Come on, markets, you figure it out yourself. You know, you're you're you know you're you're mature, you can you can you can work it out. Uh and he wants market forces to work. And on the other hand, we've now got the Treasury who's saying, actually, we don't want market forces to work, because we don't like where these yields are because it's market forces that have driven them up there. So we've got mixed messages. We've got the Treasury and Besson saying, you know, we're intervening, we're suppressing the long end because we don't like the market levels here, the markets don't get it. And we've got the chair of the Fed saying we want the markets to price uh where rates are going to go. So is it that obvious a contradiction? Uh is this just creating a market uncertainty that's perhaps a good thing to find prices? But I'm a little concerned about the mixed messaging from the biggest economy, the most important financial market in the world.
SPEAKER_01Absolutely. I mean, that's exactly the deeper meaning, the deeper layer of what I just pointing out about the contradiction. I mean, we as you say, we currently see it in in communication, in the the the the the kind of the trying to put a lid on longer-term treasuries, but the the deeper meaning is exactly what you pointed at. I mean, the Fed is moving away from trying to guide markets and and having an influence on markets, which I find is a reasonable approach up to a certain degree, while the Treasury is doing exactly the opposite. They're trying to to manage markets more, they're trying to intervene more in markets. So it is confusing, and usually these things will lead to more volatility and clearly they do lead to more uncertainty because eventually we'll have to decide. We as investors will have to decide, okay, who will prevail? Who what exactly is the is the end game? And as we just said, I mean, usually that's exactly the environment, exactly the situation where markets will test the resolve. Not only of the government, the administration, obviously that's maybe the first target, but also of the Fed. Because the Fed, as you say, kind of is taking itself a little bit back, is kind of trying to step back from the game, but eventually they might not be able to do so. Might they might be forced back into the game by maybe supporting the Treasury or not. We will have to see how these things will resolve themselves.
SPEAKER_00One other area area that there's been some confusion uh again over the last couple of years is the dollar. You know, on the one hand, uh the president said, you know, he wants to see a weaker dollar. It seems uh the Treasury Secretary implied a stronger dollar, and it's kind of back and forward here. What is very notable given the current action um is the dollar has has weakened. It often the the lightning rod to express the impact of some of the these policies. So the dollar has weakened. Um is that part of the strategy, you think? I mean, because as you said, the the actual purchase of the these bonds, it's not massive in scale, but it sent a signal to the market and the dollar has has clearly weakened. So how does the dollar fit into this dynamic that we're speaking about here? Is it the point of focus or is it a residual?
SPEAKER_01Well, I think it could be both. You know, first of all, it's clearly a residual because if you let's say if you hold you put a lid on long-term treasuries, but you still have a market that works currently. I mean, there's still an ethics market. People can still buy and sell treasures, they can still buy and sell dollars. So the obvious way to to show your um or or to to to express your future views and expectations about where the US economy is going, where maybe interest rates are going, would be the currency. And that that's exactly what you're doing. So the immediate reaction after the treasury's intervention was the dollar actually weakened. And it weakened against uh, well, not only on the other currencies, it also weakens against gold, for example. Gold prices jumped in dollar, but also interestingly against cryptocurrencies, for example, which can be perceived as uh a new version of gold, at least uh for for some investors. So Bitcoin had its best week in a very, very long time. Um so clearly the market is signaling: look, if we are not allowed to to put a price on treasury bonds, we'll then use the dollar as kind of uh an exit, uh, as as as to to put off uh uh takeaway steam and and and pressure. Now the the second question, is that on purpose? Is that a policy? It might be it might not be the primary target, I think. It's it's really mostly about it, but clearly it's probably not unwelcome given what the administration has signaled in the past that they do prefer a weaker currency. And to some degree, well, you could argue yes, the dollar has strengthened over the past few months. Now they're taking some of that strength uh out out again. Um so clearly it's it's maybe a residual that is still welcome to some degree. But then again, if we close the loop and and go back to the Fed, now with a weaker dollar, again that loosens financial conditions. It will increase to some degree inflation expectations, which once again might put the Fed in a dilemma if they worry even more about inflation via imported goods and services for that matter. So you see the whole thing does create a rather uncomfortable dilemma, a situation both for investors, because first of all, we'll have to see what's exactly the resolve, how much are they willing to do, how far are they willing to go, and the Fed's reaction. Because the Fed is still uh uh committed to price stability. I mean, Kevin Walsh made that very, very clear during his first press conference. So eventually they would have to react first verbally and maybe even by actions.
SPEAKER_00Now, if we look at the market reaction to the the twist that we've seen, um despite what I said that you know investors often take policymakers on when they see um them blinking, if you like, or they see a pain point being reached. That hasn't really happened. I mean, to to be fair uh to uh Bessent, uh he has achieved in the short term, and we're talking a few days here, what he wanted. So we saw that you know the the yields move back in, 30 year, we saw the 10-year come back in from the kind of 473 level. We're now before below 470. Um so that would imply that the market uh takes them seriously. They might not be scared of them, but they believe that they're they're they're true and they will come back with more firepower if need be. Is that how you see it, or do you think actually, you know, this is just a blip again and the direction of travel is still higher for these bond yields?
SPEAKER_01No, overall I do think, first of all, I I I do think that this policies will work to some degree, and it will be helped by our overall standing view that probably inflation is going uh to be less of a threat than in coming years than it was in the past. Uh plus also growth probably is is at the peak or maybe past the peak. So all these bigger forces should also help to put a lid on on treasure yields. But then again, it's also not an unreasonable thing to do. Even if you doubt um how much they can actually influence uh uh interest rates, you probably would be a bit more cautious as an investor, for example, to bet against the treasury or to bet against the Fed. Because as I said, I mean currently they only announced uh doubling their purchases from two to four billion. That sounds relatively tiny, but in theory they could do much more. And you never know whether maybe at some point the Fed also steps in. It hasn't signaled anything in that regard, quite the opposite, as I said. But you don't know. So by creating this uncertainty, I'm sure that some investors at least with a lower conviction level, they would now be much more reluctant to maybe bet against the treasury. So to some degree, you are putting a lid on interest rates, unless obviously something big really spoils it, and let's say, for example, very bad inflation numbers or uh or a massive acceleration of growth with much more investment in CapEx needs, these could all drive in interest rates uh much higher. But fundamentally, and I think that's why the policy currently could work, fundamentally, I do think treasury yields, longer-term treasury yields are actually quite stretched, are not unattractive. So at this point, at this level of equilibrium, I think the policy could work.
SPEAKER_00I mean, I think the point that you make is it's the point at this point, because I think my fear would be really until we address the fundamentals, the direction of travel I think is still higher for bond yields. As an investor, if deficits are not being brought under control, if debt levels continue to rise, then I want a greater uh risk premia baked into the yield that I'm prepared to lend the government money at. So I think maybe the buy time, maybe in that time that is bought, maybe they can do something in the fundamentals. But I think it's quite a big ask. And as we spoke about earlier, there's a global element here that that also has a knock-on effect in terms of the the market itself. Maybe just to uh to kind of wrap this up, I mean, a couple of things. One is what do you think the the reaction function of the Fed is? I mean, you mentioned that it could mean that they they have to be a little bit more hawkish given what we're seeing. Is that is that likely given the current current construct environment we're in? And maybe just to conclude on your your your take, because I know that you're thinking that bond yields by the end of the year are likely to be to be lower than the current level that we're seeing. Is that is that fair?
SPEAKER_01Yeah, exactly. And that's also why I do think the policy, the Treasury's policy can work. I mean, uh if you try to artificially inflate a currency, for example, or put uh uh a far too low uh lid on yields, that probably wouldn't work because it really works too far too strongly against market fundamentals. But currently, uh at these levels, which I consider to be a rather stretch, I think the policy could work. Now for the Fed, clearly at the margin, we are moving towards a uh a situation with looser financial conditions, which is not what the Fed currently wants to see. But I don't think it will tip the needle in in the near term. I don't expect them to suddenly turn around and now hike rates at their next meeting, for example. But clearly they might be a bit more cautious with regard to inflation expectations, which are holding in reasonably well, or actually very well too for that for that matter. So that that's a very important point. And if uh we do see a continuation of uh weaker labor markets, of le of uh weaker employment conditions, which we have seen, payrolls actually did fall uh last uh last last month. So that's not an environment that is screaming for rate hikes. So I think currently, as you pointed out, the Treasury buys itself some time. If we do see the bigger forces of inflation fading, of maybe growth not accelerating, and maybe even the AI capex cycle not accelerating further, which kind of also should reduce some pressure on on bonds, then I think buying time would have been just enough to go over the hum. But you're right, I mean that still doesn't solve the underlying problem, which is a five to six percent deficit in kind of let's let's say peacetime, not so peaceful these days, but still peacetime, uh and non-recessionary uh period. That is unusual and that needs to be addressed. Now, unfortunately, we had several different uh political situations and none of these, none of uh the governments, none of uh uh uh the the houses in Congress have actually tried to really address the fundamental issue of the fiscal balance of the fiscal deficit. So unfortunately, it doesn't look like it will change in the near term. And eventually the pressure will be high enough that something needs to be done. I mean, even Scott Besson himself, he argued for a 3% deficit, not a 5% deficit. But just so far we haven't seen any concrete measures. So we're still waiting for that.
SPEAKER_00I mean, that's always the trouble. You know, the the policymakers can talk a good story in power, it's then much harder to remove that punch bowl when things are going fairly well. So we'll have to wait and see. Tom, as always, thank you very much. Um, thank you to our viewers and listeners. I encourage you to do read the paper. Uh let's twist again. No dancing involved here, but please uh do have a look. Uh let us know your your thoughts as well. It's always good to get your opinion and your your views around that. Remember, all our publications and videos are on zuric.com. Please like and subscribe, and we'll be back with you again very soon.