Bond market is regaining discipline after years of Fed repression, Wolf Street says

Bessent, rather than touting hocus-pocus shows, should point to the growling bond market as a reason to get serious about fiscal consolidation before the bond market starts to bite.

The $32 trillion Treasury market — the publicly traded portion of the $40 trillion in total Treasury debt — has given Treasury Secretary Scott Bessent a mild lesson after he carried out Hocus-Pocus 1, the joint US-Japan yen intervention at the beginning of August, and Hocus-Pocus 2, the announcement last Wednesday that Treasury buybacks — in which the Treasury repurchases older, off-the-run securities using funds raised from new issuance — would be doubled. Both were intended to push long-term Treasury yields lower. Yields did fall for a day or two, but then rose again and erased the decline.

The message from the bond market was clear: do not mess with it, and do not play games with it. Such maneuvers only whittle away at credibility, make the bond market nervous, and a nervous bond market will demand even higher yields. The bond market wants solutions to its main problems: deficits and inflation.

The US government depends heavily on the bond market to finance its enormous deficits, which have run at around 6% of GDP for the past four years through 2025 and are in the same range in 2026. For perspective, federal deficits averaged roughly 3% of GDP over the five decades before the pandemic.

This was only a mild rap on the knuckles. It was not serious. It was also another sign that the bond market is finally functioning again after 14 years of being subdued by the Federal Reserve’s interest-rate repression, often described as financial repression — the practice of holding yields below inflation so that debt is quietly eroded over time.

When the Fed began quantitative easing (QE) in late 2008, buying Treasury securities and mortgage-backed securities in the trillions of dollars with newly created money, it forced bond prices up and yields down. In the process, it transformed the bond market from a generally gentle but potentially vicious guard dog into a lapdog.

That lapdog, willing to go along with almost anything, contributed to major damage, including what the article describes as unspeakable profligacy by the government. Easy money allowed the government to become addicted to nearly free financing, helping produce the $40 trillion in Treasury debt.

That was not Bessent’s fault. But he took the job of selling those bonds, come what may, and that task is becoming harder.

The Fed’s bond purchases began during the Financial Crisis and, aside from one interruption, continued until early 2022.

During the pandemic, the Fed went haywire, as did the federal government. In just March, April, and May 2020, the Fed bought about $3 trillion of Treasuries and mortgage-backed securities while the government issued roughly that much in new Treasury securities.

That was financial repression at its maximum. In the summer of 2020, the 10-year Treasury yield fell to 0.5% and the 30-year Treasury yield was just above 1%. Some market participants were even discussing the possibility of long-term Treasury yields turning negative, which would have been the only reason to buy long-term Treasuries at those levels.

Since January 2020, Treasury debt has grown by $17 trillion, from $23 trillion to $40 trillion in 6.5 years, and it has continued rising, including by $1 trillion over the past three months alone. The article calls this beyond reckless and says the Fed aided and abetted it.

The Fed’s balance sheet expanded tenfold, reaching nearly $9 trillion at its 2022 peak, up from $900 billion in 2008. This interest-rate repression created a range of historic distortions.

By the summer of 2020, the bond market had essentially died. It was no longer pricing risk, inflation, or the huge wave of issuance that had to be absorbed. It had lost all signs of life and had ceased to function as a bond market.

But then came the first signs of life. Despite continued QE at a pace of about $120 billion a month, bond yields began rising in late 2020. Slowly, risk began to matter again.

By the time the Fed finally ended QE in early 2022 and switched to quantitative tightening (QT), letting securities roll off its balance sheet rather than replacing them, inflation was surging toward 9%, the worst in 40 years, and home prices were exploding as buyer mania took hold, driven by mortgage rates below 3%.

Meanwhile, the government continued to run huge deficits, spending heavily. In fiscal 2020, the annual deficit-to-GDP ratio reached 14%; in fiscal 2021, it was nearly 12%; and from 2022 through 2025 it hovered around 6%, despite above-average economic growth. For fiscal 2026, the Congressional Budget Office projects a deficit of 5.8%, essentially the same as last year.

Even so, the bond market kept financing these deficits without much resistance. Long-term yields rose as the Fed reduced its securities holdings during QT and raised its policy rates in 2022 and 2023, gradually stepping away from interest-rate repression and shifting the job of absorbing record issuance back to private investors. But the Fed has not fully stepped back. Its still-large holdings of Treasury notes and bonds, which it replaces as they mature, continue to keep a thumb on the scale, though to a much smaller extent than before.

Kevin Warsh, the new sheriff in town, has said repeatedly that he wants to move the Fed further out of the bond market’s way. Before becoming Fed chair, Warsh — a former Fed governor — criticized the problems caused by the Fed’s interest-rate repression through QE. He is determined to reduce the Fed’s balance sheet.

Any major move, however, is decided by vote, and he needs a majority on the 12-member Federal Open Market Committee, the panel that votes on the Fed’s rate and balance-sheet decisions. That takes time. So far, there has been one small step: as of mid-August, the Fed stopped the “Reserve Management Purchases” of T-bills after tapering them in the previous two months. The RMPs were started by the Powell Fed in December to re-inflate reserve balances. The Fed is now only purchasing T-bills to replace the MBS that roll off the balance sheet at a rate of about $17 billion a month.

The Fed’s balance sheet remains huge at $6.75 trillion and still affects the bond market, though far less than during the era of interest-rate repression. Discussions about the size and composition of the balance sheet, along with coming recommendations from Warsh’s balance-sheet task force, were mentioned in the minutes of the last meeting. Any decisions, however, still require a majority on the FOMC.

Warsh wants the bond market to do its job and to get the Fed out of its way, despite substantial institutional resistance inside the central bank.

The bond market is gradually coming back to life

The first real sign came in the fall of 2023. Amid projections from the Yellen Treasury of massive issuance of notes and bonds to fund deficits, and with no effort being made to reduce those deficits, inflation still hot, QT still underway, and Fed policy rates above 5%, the bond market fired the first major shot across the government’s bow.

The 10-year yield surged and briefly moved above 5% at the end of October 2023 — the first time it had crossed that threshold since 2007 — alarming Treasury Secretary Yellen. By April 2024, she responded with the now-infamous Treasury buybacks — the same kind of hocus-pocus show that a rattled Bessent plans to double starting in September.

Despite that warning, deficits continued to balloon. That, the article says, is the real problem — not the current 10-year or 30-year Treasury yields.

The second real sign came in August, when long-term yields surged despite Bessent’s Hocus-Pocus Shows 1 and 2. How the doubled buybacks actually run from September, and what Warsh’s balance-sheet task force recommends, are the immediate test cases.

Buyers in the bond market are now pricing in some risks and demanding compensation for taking them. More and more new buyers must be drawn off the sidelines and into the market with higher yields. As deficits rise and risks accumulate, the cost of funding rises too. And because Treasury yields serve as the benchmark for borrowing costs across the economy — mortgages, corporate bonds, car loans — this repricing reaches well beyond the government’s own financing.

Borrow too much, go broke — that is what happens on Wall Street. It does not happen to the federal government in the same way. What does happen is higher yields, higher interest payments, and higher inflation until Congress cries uncle and starts addressing the deficit. Interest on the debt has already climbed to rank among the largest single line items in the federal budget.

Bessent, rather than trying to influence the bond market with hocus-pocus shows, should work to bring the White House and Congress on board for fiscal consolidation and use the growling bond market as a reason to get serious before it starts to bite and tear out a piece of flesh.

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