Scott Bessent to the Rescue of the Bond Market: Will He Succeed or Be Overpowered?

There was no agreement with Iran "in a day or two" as promised by Trump and Scott Bessent, the Treasury Secretary. Instead, there will be "unprecedented" economic sanctions aimed at subduing their will. The price of crude oil reacted accordingly, with Brent crude once again surpassing $90 a barrel. With energy prices rising, Wall Street could no longer pretend to be oblivious. The promise of imminent peace was the tranquilizer that calmed the anxiety of the yield curve. However, after the 10 and 30-year Treasury bond auctions, the medicine was canceled. It should also be noted that there was no sudden tantrum from the bonds as feared. Nothing like the "taper tantrum" that hit the Fed under Ben Bernanke in 2013. There was no 100 basis point whiplash this time. It was different. The irritation of the bonds escalated slowly, and Bessent intervened before the tantrum exploded. Prevention is better than cure. Of course, the Treasury Secretary is not here to remedy the deficit or trim the debt. He is only here to scratch the itch.

Once again, Bessent to the rescue. It is his specialty (as an official). He treads familiar ground -- bonds and currencies -- that he used to lurk around when he was also a bond vigilante. For that reason, since Trump took office, he has also been the main person responsible for looking after him. The instruction he received then was simple. "Long-term rates must come down immediately." And so it was. In January of last year, during the last days of the Biden Administration, the ten-year rate hit the cycle high -- 4.80%. Bessent would then ensure its sustained reduction with remarkable success until Trump unleashed the war in Iran. It is striking because, in the meantime, neither the deficit nor public debt ever stopped growing. However, there was no crisis when Congress approved the tax cut package last year. Nor when the Supreme Court ordered the return of all revenue collected from improperly charged reciprocal tariffs.

How did Bessent manage to sedate the bond vigilantes for so long, when they are so skittish today? He didn’t need to invent anything. He did the same thing he criticized Janet Yellen, his predecessor at the Treasury, for. Only with much greater intensity. Essentially, he shortened the duration of public debt issuances. He increased the volume and relative weight of Treasury bills (instruments that do not exceed one year). Since the bills are issued at a discount, they also do not pay explicit interest. Ten years ago, they represented between 10% and 15% of the Treasury's negotiable debt. Today, 22%. Thus, when the tax package was discussed, Bessent convinced the bond vigilantes that any increase in the fiscal deficit would be absorbed by the short end of the curve. For them, under those conditions, its approval was a "non-event."

It was also Yellen who resumed regular buybacks of old debt issues in 2024 (abandoned in 2002). Bessent significantly increased them. There were not too many complaints then. Now, however, complaints are pouring in since he announced that he will expand them to calm the storm. It is just a token -- $14 billion in an ocean of $32 trillion in public debt - although it constitutes an important signal. Bessent is confident that his bag of tricks will prevail again. So much so that he doesn’t even pretend to tidy up the fiscal accounts to cover appearances.

It was written in this column: General Trump spoiled President Trump's plans. The war in Iran began on February 27. The ten-year rate hit a low of 3.93% on March 3. From then on, everything went uphill. Almost six months later, on Tuesday, it brushed against 4.75%. The debacle of the 30-year bond was more pronounced. And striking. Its yield reached 5.33%, the highest in the last 25 years. And, as mentioned, Bessent jumped into the fray with his announcements before the turmoil erupted. He halted the procession while it was still advancing in order.

What spoiled the framework that Bessent carefully and successfully built until March? Was it the war? Yes. Brent crude started the year at $60 a barrel and today costs 53% more. However, the inflation expectations implied in bond prices did not change. Fortunately (otherwise rates would be even higher). Inflation rose. Medium-term expectations did not. Nevertheless, nominal rates climbed alongside real interest rates. Was it the boom in artificial intelligence (AI), then? It also contributed. Not only because investment spending skyrocketed. Hyperscalers, who once financed themselves with their own savings, had to resort to huge debt placements. And they did not avoid long terms. Alphabet, for instance, issued a centennial bond. The duration that Bessent removed from the markets with the intensive use of Treasury bills was replaced by AI placements (and then some). But the Fed, led by Bessent's friend Kevin Warsh, also played a role. Sitting on their hands and blocking the initiative to raise the fed funds rate promoted by Logan, Hammack, and Kashkari in July added pressure on longer rates. And their turmoil forced Bessent to get involved.

Where do we stand today? The imaginary deal with Iran has collapsed. Someone convinced Trump that he must tighten the screws more. It is known that the crude market will not like it. Will the barrel return to trading above $100? It is clear that this way the improvement in inflation in June and July will be reversed. The Fed meeting in September will be one to watch closely. Trump does not doubt Warsh, but can he retain the support of the majority? And if he does, who will take care of calming inflation? The Treasury's intervention operates in this backdrop. The government intends for the markets to finance the fiscal deficit plus the next phase of the war in Iran (which implies greater tension in energy markets) plus the AI boom, all without slowing down a bit and simultaneously, at rates that are not much higher than those currently in effect. But there is more: the Fed will be asked to lower rates so that Warsh can keep them unchanged, safe from the increase instigated by dissenters. Is that not too much?

What capacity does Bessent have to carry out this agenda? More than is accepted at first glance. It must be understood that this is a very short-term patch. The additional buybacks announced by the Treasury cease on November 4. The midterm election is held a day earlier. An agreement with Iran that reopens navigation through Hormuz -- and the vertical drop in energy prices -- would render this entire discussion abstract. And from now until November, it is very likely that Trump will change his military strategy, and even several times, if the results are not as expected. Restoring a truce that preserves the ambiguity of the status quo would also serve to ease tensions.

That said, if Bessent's intention is to suppress (or slow down) the rise in rates in a specific segment of the bond curve - the long end - he can achieve it. Of course, there are two segments he aims to anesthetize, as he also rejects changes in the short end, which is managed by the Fed. The markets, which will test his determination in the ten-year arena, have already adjusted. Rates have risen in the "belly" of the curve: from two to seven years. And they have taken the liberty to "short" the dollar knowing that a moderate drop will not cause discomfort. Rather, it will help Bessent sustain the Japanese yen (his penultimate intervention). Another reverberation, the strong rally of bitcoin, on the contrary, fits perfectly with the legislative agenda pushed by Trump, the Clarity Act. And it is also presumed to align with the investment portfolios of the family. Finally, for the stock market, a tantrum from the bonds was an imminent danger. The Treasury's move is a mess and a scandal. But if his zeal removes the danger, although he does not say so, it will be preferable for him.

Bessent, who has already indicated that he can increase the size of the buybacks beyond the 14 billion dollars announced, presented them as a liquidity support operation. That is, he will buy old long-term debt issues, which are illiquid and offered at high yields (low prices). And he would fund them with new issues, which enjoy ample secondary liquidity and lower rates. This voluntary transaction could be carried out with a profit for the treasury and in a significant volume. But it is the rates of the liquid issues that motivated, in the first place, his reaction. It is not evident why grouping them into a larger set should significantly cut their yields. That is not the problem. Therefore, it will not be the solution either.

The markets (over)understand - that’s why they talk about a twist operation - what Bessent did not say: that he will finance the buybacks with new debt issues of shorter duration. This explains the rise in rates in the belly of the curve. Although the first transaction to corroborate this will only be executed on September 9. It is worth knowing lastly that Bessent could, plain and simple, reduce the placements of new debt if the markets decide to confront him (even without the need to make buybacks). If that happens, he could try it across all segments of the curve. The Treasury's cash holdings - which hover around 900 billion dollars (the equivalent of a five-month fiscal deficit) - place him in a position of great flexibility. Ironically, even without lifting a finger to curb the overflow of public accounts. In fact, that is what he is forced to do every time politics triggers a government "shutdown".

Winning the standoff, however, will not prevent the erosion of the Treasury's credibility. But that is another story. And it has an antidote. The Fed - which is responsible for ensuring price stability - could reinforce its credibility if it takes the bull by the horns. A modest increase of a quarter point in the fed funds rate will suffice to achieve this. If Chairman Warsh promotes it, so much the better. But it is not necessary either.

Paradoxically, the Fed, if it acts this way, with clear independence, will facilitate Bessent's effective deflation of long rates.

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