Bessent On Bonds; Warsh On Inflation

BESSENT ON BONDS LAST WEEK

Treasury Secretary Bessent said last Wednesday that Treasury would roughly double long-dated buybacks (of U.S. Treasuries) to at least $4 billion per operation beginning in September. The bond market responded strongly, and so did gold, while the U.S. dollar fell sharply against other fiat currencies.

At the time, the markets seemed to see more than is readily apparent. The plain facts of the action pale considerably when you consider these facts…

1. $4 billion is a drop in the bucket compared to the total market for U.S. Treasuries, which totals something north of $31 trillion. The proposed monthly buyback addition is the equivalent of .000129% – not exactly a substantial amount.

2. Government intervention and manipulation in the currency and credit markets are part of day-to-day activities. Why should an insignificant amount of activity generate such big reactions?

Possibly, the markets were looking beyond the specifics at an assumed effort by Treasury to contain yields, especially long-term ones, where a large amount of Treasury debt is concentrated. Treasury has also emphasized that the buyback program is not about altering maturities as much as it is designed to improve liquidity.

That is well and good, but is it deserving of the strongly positive upward spike in bond prices that occurred? Apparently not, since most of that gain was given back quickly.

WHAT ABOUT GOLD AND THE DOLLAR? 

For the U.S. dollar, traders must have thought the bugler had sounded retreat. Similar action followed Secretary Bessent’s announcement that the U.S. had intervened in the currency markets to help prop up the Japanese Yen less than two weeks ago, ostensibly to limit volatility in the markets. Is Treasury’s latest foray into battle a reason to expect dollar weakness? Or just the opposite? If the Treasury is serious about curbing inflation, that would seem to be positive for the U.S. dollar.

As far as gold is concerned, the action resembled poking a sleeping bear. Apparently, the bear had not gone back to sleep. Some of gold’s reaction is certainly tied to a weaker dollar, although gold remains down nearly 20% from its peak price earlier this year.

KEVIN WARSH ON INFLATION THIS WEEK

Kevin Warsh spoke more plainly on Friday (28th) about the Fed’s intentions as related to inflation: “Inflation is running above our 2% target. So the Fed’s predominant focus right now should be on prices.” Investors pounced on this and the odds favoring a rate hike at the Fed’s September meeting increased dramatically.

The U.S. dollar was sharply higher on currency markets, and gold fell more than 3%. The Warsh remarks provoked a decidedly different reaction than accorded to Mr Bessent’s announcement. Why?

BESSENT ON BONDS

Treasury Secretary Bessent’s remarks in August – 1) intervention re: Japanese yen; 2) purchase of long-dated Treasuries – indicate justifiable concern about two major issues affecting the financial markets: volatility and liquidity. These issues are harder to address through the lens of credibility, given the Treasury’s limitless appetite for deficits and debt.

The increase in direct (official) intervention was a clear sign of intention to support the bond market; i.e., the Treasury bond market. That was interpreted as “quantitative easing” and lessened the odds (in investors’ eyes) of higher interest rates. Hence, temporarily higher bond prices, a weaker US dollar, and higher gold prices.

Regardless of statements and respective actions, the risks of more volatility and collapse in bonds and stocks (all markets) remain heightened.

WARSH ON INFLATION

Warsh’s comments about the Fed’s primary focus on price stability, and that inflation is higher than desired, sound reasonable. It also resembles the old story of running to close the barn door after the horses get out.

Inflation starts with the Federal Reserve. Since its inception in 1913, the Fed has debased the currency by continually expanding the supply of money and credit. If the Fed were serious about “fighting inflation”, then STOP INFLATING.

The consequences of inflation are volatile and unpredictable, but there is always an ending. Most of the time, the ending is ugly.