Bessent's bond move isn't going the way he planned

Treasury Secretary Scott Bessent aimed to calm a nervous bond market with a move to double the size of long-dated debt buybacks. However, the initiative may have instead provided investors with a fresh reason to be concerned, extending beyond the trading floors that monitor government debt. This case underscores the constraints of financial maneuvering as much as it highlights the current state of government debt ahead of a significant speech.

The scenario also occurs at a time when patience for reassurance is dwindling. Inflation expectations have risen in recent days, prompting investors to price in higher inflation. This is evident through the breakeven rate, which has surged across the curve to its highest point in over two months. On August 20, the 10-year breakeven rate hit 2.34%, marking its peak since June 10.

Similarly, the five-year breakeven rate surged to the same level for the first time since June 16. Such fluctuations, while typical, indicate growing apprehension about inflation among bond investors. The catalyst for this shift is the Treasury's announcement on August 19 to increase the size of its long-dated debt buybacks from $2 billion to at least $4 billion per operation, starting September 9 and running through November 4.

This move came after the 30-year Treasury yield touched levels unseen in nearly two decades. Despite initial relief as yields briefly dropped and the dollar weakened, the gains were short-lived. Long-dated Treasury yields rallied the day of the announcement but retraced and climbed again on August 21, erasing most of the initial gains.

This suggests that Wall Street remains skeptical about the effectiveness of Bessent's buybacks in curbing yields. The skepticism goes beyond a one-week period. JPMorgan strategists argue that the operation does little to address the underlying factors driving higher Treasury yields, such as persistent fiscal deficits and escalating inflation expectations.

The timing of the buyback announcement, coupled with record-low foreign demand for U.S. government debt and rising yields from other regions, has heightened investor skepticism. The Treasury's move comes amid a backdrop of higher-yielding debt in Asia and Europe, a surge in corporate issuance by AI-focused companies, and a general rise in the term premium demanded for holding long-term U.S. debt.

The market's divided reaction underscores the challenges faced by Federal Reserve Chairman Kevin Warsh, who will deliver his keynote address on August 28 at the central bank's annual symposium in Jackson Hole, Wyoming. Investors are eager to hear whether Warsh will endorse a more dovish stance or maintain an accommodative tone. Warsh's previous statements supporting a reduced Fed role in markets have been interpreted as dovish by some investors.

If Warsh signals a continued accommodative stance during his speech, breakevens could rise further, potentially undermining the stability achieved by Bessent's buybacks at the long end of the curve.