Bessent on Bonds; Warsh on Inflation

By Kelsey Williams

Bessent on Bonds: Last Week

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

At the time, the markets seemed to see more than was readily apparent. The plain facts of the action pale considerably when considered closely.

$4 billion is a drop in the bucket compared with the total market for U.S. Treasuries, which totals something north of $31 trillion. The proposed monthly buyback addition is the equivalent of 0.000129% — not exactly a substantial amount.

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

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

For context, regular Treasury buybacks are a liquidity-management tool: the Treasury funds purchases of older, less liquid off-the-run issues by issuing new debt, aiming to keep trading conditions smooth in the secondary market rather than to change the overall size of the debt. Investors, however, have historically been quick to read such operations through the lens of quantitative easing — the Fed's large-scale asset purchases of the post-2008 era — which is one reason even a modest program can move prices sharply.

That is well and good, but was 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 less than two weeks ago that the United States had intervened in the currency markets to help prop up the Japanese yen, ostensibly to limit volatility in the markets. Is the 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 (the 28th) about the Fed's intentions regarding 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 the one accorded to Mr. Bessent's announcement. Why?

Part of the answer lies in expectations. The 2% figure Warsh referenced is the Fed's long-standing formal inflation target, adopted in 2012, and markets price Fed funds futures off expectations about how forcefully policymakers will defend it. Words from a Fed official that signal a harder line on inflation therefore translate quickly into repriced rate expectations — and, in turn, into moves in the dollar and gold — even before any policy action is taken.

Bessent on Bonds

Treasury Secretary Bessent's remarks in August — 1) intervention regarding the Japanese yen, and 2) purchases 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; that is, 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 U.S. dollar, and higher gold prices.

Regardless of statements and respective actions, the risks of more volatility and of a collapse in bonds and stocks (all markets) remain heightened. (See Bond Market Crack Widens.)

Warsh on Inflation

Warsh's comments about the Fed's primary focus on price stability, and that inflation is higher than desired, sound reasonable. They also resemble 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 it should stop inflating.

The consequences of inflation are volatile and unpredictable, but there is always an ending. Most of the time, the ending is ugly. (See An End to Inflation.)

About the Author

Kelsey Williams is an analyst, author, and owner of Kelsey's Gold Facts. He has more than forty years of experience in the financial services industry, including fourteen years as a full-service financial planner. His website contains self-authored articles written for the purpose of educating and informing others about gold within a historical context. In addition to gold, he writes about inflation and the Federal Reserve. Kelsey is the author of two books: Inflation, What It Is, What It Isn't, and Who's Responsible for It and All Hail the Fed! He is available for private consultations, public speaking, and interviews at kwilliams@kelseywilliamsgold.com.

Source: GoldSeek — original article