Treasury Secretary Scott Bessent becomes the tip of the spear in the war on Iran and the bond vigilantes as the U.S. readies more financial firepower

Facing a challenging situation with Iran and a weakening bond market, the Trump administration has placed trust in Treasury Secretary Scott Bessent to utilize financial tools to secure success in both areas. The strategy involves pressuring Iran to fully open the Strait of Hormuz, which would lower oil prices and alleviate pressure on the bond market as investors become less concerned about inflation.

However, Bessent faces a difficult task in attempting to compel an Iranian government that is determined to maintain control over the strait. On Monday, it is anticipated that Bessent will reveal the "economic D-Day" that the U.S. plans to execute against Iran, targeting countries that do business with the regime. Bessent's Financial Times op-ed stated, "Any nation that acts as a financial artery of a weakening regime should anticipate sharing in its isolation."

Sources revealed to Reuters that the Treasury Department intends to broaden the application of secondary sanctions against entities and countries engaging with Iran, threatening to isolate violators from the dollar-based financial system. Iran has frequently utilized shell companies to circumvent U.S. sanctions, and these new measures are expected to add categories of Iran-related actions, even in a third country, that would be subject to secondary sanctions.

This could pose a significant challenge for Chinese companies involved in Iran-related transactions, potentially complicating President Donald Trump's upcoming summit with Chinese President Xi Jinping in late September. The United Arab Emirates, historically a key ally in providing Iran access to global markets, has already imposed an embargo on trade and transactions with the Islamic Republic.

Iran's economy is facing severe strain due to the U.S. naval blockade, which has significantly reduced oil exports and critical imports. This has raised concerns among top Iranian officials, with parliamentary speaker Mohammad Bagher Ghalibaf warning of the dire consequences of economic hardship and advocating for negotiations with the U.S. to avoid further conflict.

The bond market war against the "bond vigilantes" is another area where Bessent is actively engaged. The term "bond vigilantes" refers to traders who protest large deficits by selling off bonds, driving yields higher. With the deficit projected to reach $2 trillion this fiscal year despite economic growth and low unemployment, the bond market has shown little patience, as lawmakers have not shown any intention of curbing spending.

Bessent surprised Wall Street last week by proposing to increase the purchase of long-term bonds, following a 30-year yield that reached its highest level in nearly two decades. While the $4 billion buybacks were relatively small compared to the $32 trillion Treasury market, Bessent may have even more resources at his disposal to counteract the bond vigilantes.

Sources close to the matter told CNBC that Bessent could utilize the Treasury Department's general account to expand the scale of the bond buybacks. This general account, funded by tax revenue and built up to $950 billion under Bessent, compared to $550-$600 billion during the Biden administration, could provide the necessary funds.

However, this increased involvement in financial markets has raised concerns about the potential for financial repression, which involves influencing markets to keep interest rates artificially low.