You Can’t Buy Your Way Out of a Fiscal Problem
From the Desk of the CIO
The Treasury has spent the last month trying to talk the long end of the curve down, and the long end has declined the invitation twice. While it does not mean Treasury’s buyback program was a failure, it certainly means there are limits to what a debt-management tool can accomplish when the market is repricing duration, inflation and fiscal risk.
I want to explain what Treasury did, what happened, and what the market is likely telling us.
What Was Done
On August 19, with the 30-year Treasury yield near a 19-year high, Secretary Scott Bessent announced that Treasury would increase the maximum size of its long-end liquidity-support buyback operations from $2 billion to $4 billion per operation. Treasury also increased the frequency of these operations, targeting the 10-to-20 and 20-to-30 year sectors through November 4. The stated purpose was liquidity support, but the broader message was difficult to miss. The administration wanted lower long-term borrowing costs, and Treasury was signaling that it was prepared to step in as a larger buyer of long-dated debt to help achieve that. This was further reinforced by its September announcement, again increasing the maximum size of each operation, from $4 billion to $6 billion.
What Happened
While the August announcement produced a rally that lasted approximately one day, the September announcement did not even manage that. The 30-year hit an intraday high of 5.30%. The following 10-year auction cleared at 4.834%, the highest since August 2007. The 30-year sits at 5.35% as I write (the highest since 2007), and has now spent over 50 days above 5% this year, which is the most since 2006. If the conversation earlier in the year was about the credibility of the Federal Reserve, it has certainly shifted (at least, temporarily) to that of the Treasury because the Treasury Secretary of the United States announced he was stepping in to buy long-dated government debt, and the long end sold off. Twice.
To be clear, the September auction itself was successful, but Treasury bought back low-coupon debt in a higher-rate environment, while new financing carries substantially higher yields. At the margin, that raises the government's cash interest burden in pursuit of a marginal improvement in the long bond, which is becoming ever more problematic since Interest is now the second-largest line item in the federal budget, and “the Congressional Budget Office (CBO) projects that if current laws generally remain the same, net interest payments will total $16.2T over the next decade, rising from an annual cost of $1T in 2026 to $2.1T in 2036. Relative to the size of the economy, interest costs would reach 3.2 percent of gross domestic product (GDP) this year — eclipsing the previous high set in 1991. Interest costs would climb to 4.6 percent of GDP by 2036, under CBO’s projections.” (Peterson)
Thankfully, there is no shortage of dealers or of liquidity (if that were the case, this would be a completely different piece) and the United States is unlikely to fail to roll its debt. What we are seeing here is a selloff in long bonds because holders are demanding greater compensation for being asked to fund an unsustainable fiscal trajectory only Congress can fix.
Why Treasury Buybacks Have Limits
Let’s start with scale. The largest individual long-end liquidity-support operation announced by Treasury is now $6 billion. Against roughly $31.8 trillion of outstanding marketable Treasury debt, that is tiny and even a successful $6 billion operation cannot materially change the fundamental supply-and-demand balance of a $30 trillion-plus market. Treasury cannot buy a meaningful percentage of all outstanding debt, nor was it ever attempting to. Instead, it targeted specific securities in particular maturity sectors to influence the supply and liquidity characteristics of that corner of the Treasury market. That is well within its power, but it cannot dictate the price at which investors are willing to absorb that duration. That is why we are seeing yields rise despite the intervention and that is where the country’s underlying fiscal problem becomes the focal point since investors are pricing expectations for things like future inflation, economic growth and the risks associated with the fiscal trajectory.
An Uncomfortable Conclusion
Treasury has given us useful information over the past month, although perhaps not exactly the information it intended to give. It has demonstrated that it is increasingly concerned about liquidity, the structure of the Treasury market and the level of long-term borrowing costs. It has also demonstrated that a debt-management operation cannot overpower the forces determining the equilibrium price of duration.
A $6 billion operation can improve liquidity in certain targeted securities. It can also help dealers manage inventory and support the functioning of the Treasury market. What it cannot do is eliminate the need for the private sector to absorb trillions of dollars of Treasury debt, change the inflation outlook, dictate Federal Reserve policy, or erase the term premium demanded by investors for holding long-duration government bonds. Ultimately, those larger forces are what drive yields.
The buyback program may have been a relative success, but if the intended and unstated objective was to materially change the trajectory of long-term borrowing costs, the market made clear that Treasury does not have that power.
Disclaimer: The content contained herein is provided for general informational and educational purposes and does not constitute investment advice or a recommendation, offer, or solicitation to buy or sell any securities. The content reflects the writer's views and analysis as of the time of writing and is provided for context only. It does not address every factor relevant to any particular investor's circumstances, and investors should evaluate their own facts and circumstances before making any investment decision. The writer and/or affiliated funds may hold positions in the securities discussed and may buy or sell such positions at any time without notice. Past performance is not indicative of future results.
