Bessent’s bond strategy aimed at calming the market is actually fueling inflation concerns

Investors have spent the past few days pricing in the possibility of higher inflation going forward, a potential sign that the Treasury Department’s efforts this week to improve liquidity in the Treasury market are raising concerns about broader policy implications.

So-called break-even interest rates, a market-based measure that compares U.S. Treasury yields with inflation-protected securities of the same maturity, rose across the curve and hit their highest level in more than two months. The break-even point reflects not only inflation expectations but also the compensation investors seek for inflation risk and other factors.

The 10-year break-even rate rose to 2.34% on Thursday, the highest level since June 10th. The five-year break-even point also reached the same level, the highest level since June 16th. While the move may be volatile and suggests markets are not expecting runaway inflation, it also signals rising inflation concerns.

The concerns followed the Treasury Department’s announcement on Wednesday that it would at least double the size of its usual $2 billion bond buyback, a routine operation that begins in 2024 to provide a market for long-term debt.

Treasury Secretary Scott Bessent insisted the move was not an attempt to push yields down, but it did come after 10-year and 30-year Treasuries hit levels not seen since before the 2008 global financial crisis.

“The backdrop right now is very unforgiving. There are a lot of concerns that are building up,” said Van Hesser, chief strategist at credit and bond rating agency KBRA.

Traders are pricing in higher inflation, which “fits into the context of people being concerned about inflation and that continuing to depend on the market. These things kind of come and go. I think all of these risks are there and many of them have been for a while. They flare up from time to time and show up in the market.”

This week’s rise in market-based inflation expectations follows a general pattern.

Long-term Treasury yields fell sharply on the day of the buyback announcement, but rebounded on Thursday and rose again on Friday. of 10 years In early afternoon trading, the index stood at 4.73%, up 3.4 basis points on the day and above its pre-announcement level.

Similarly, 30 year yield Yields on short-term bonds also rose, rising 3.6 basis points to 5.27%. The Treasury Department is required to offset the buybacks of long-term debt with the issuance of short-term bills.

Many factors are at play in the sudden rise in yields, most notably inflation concerns. The Treasury also has to compete with high-yield bonds in Asia and Europe, a record surge in issuance from hyperscalers investing in artificial intelligence, and a general rise in term premiums that topped $40 trillion this week, or the extra yield investors demand from their holdings of U.S. Treasuries.

While yields are rising, dollar The dollar continued its trend of depreciation of nearly 0.9% this week.

Thierry Wiseman, global foreign exchange and rates strategist at Macquarie Group, wrote that the dollar’s move may also be “a result of ‘reading’ Treasury announcements on the outlook for Fed policy easing.”

“Following the announcement of increased share buybacks and the ‘signaling effect’ it evoked, the 10-year break-even point rose by about 6-7 bps, but not negligibly. This seems to say that something about the announcement was ‘inflationary,'” Wisman added.

Treasury officials did not respond to requests for comment.

The market reaction has raised expectations for Federal Reserve Chairman Kevin Warsh, who is scheduled to give a high-profile keynote speech at the annual Central Banking Symposium on Aug. 28 in Jackson Hole, Wyoming.

Mr. Warsh’s previous comments in favor of reducing the Fed’s role in markets were interpreted by markets as being dovish on inflation.

“If Mr. Warsh indicates that he will remain ‘dovish’ indefinitely, that could be self-defeating for him and the Treasury, as it would push the inflation breakeven even higher and perhaps undermine the stability in nominal long-term yields that Scott Bessent is trying to achieve,” Wisman said.

Still, some in the market don’t see the recent spike in yields as a cause for concern.

David Zervos, chief market strategist at Jefferies, said in an interview with CNBC that the 10-year bond is in one of its narrowest ranges in 20 years. “It’s not running away from anyone,” he said.

“What we’re seeing is a different kind of Treasury secretary, someone who’s willing to come in and be more tactical,” Zervos said. “This is new for the market, and the market will have to adapt to that.”

Similarly, Hesser, the KBRA strategist, said current yield levels are in line with historical norms and are a reversal after a long period of the Fed’s use of tools to keep interest rates artificially low.

“A 10-year rate of 4% to 5% is a very constructive interest rate level in a prosperous economy,” he said. “I think an interest rate of 4 to 5 percent is a very healthy rate that allows interest rates to do their job, which is to have a reasonable flow of capital throughout the economy,” he said.