Dog days of policymaking

By Atul Bhatia, CFA

Finding his footing

Fed Chair Kevin Warsh’s Jackson Hole speech last Friday corrected some of what we consider to be missteps from his remarks following the central bank’s July meeting, when his enigmatic commentary opened the door to ideas of potential changes to inflation targets or de-emphasizing interest rate policy.

The core concern we have with his approach, however, remains unresolved: his focus on avoiding forward guidance is depriving markets of necessary nuance and context.

To be clear, Warsh has a very good point on the pitfalls of the Fed committing to giving investors a three- or six-month “heads up” before it will consider a rate move. That type of guidance can help in a crisis, although it carries risks for the future.

But simply discussing how policymakers are thinking should not be an issue. Take Warsh’s Jackson Hole speech where he said that the Fed “must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.”

It’s a great sound bite, but it leaves important questions unanswered. What is sufficient speed? What data will show that it’s going there clearly? More importantly, what about the tradeoffs? Would policymakers continue to hike rates if unemployment hits six percent? What if stocks were down 20 percent or GDP contracted?

Obviously, Warsh cannot address every possible set of contingencies, but he can discuss how he thinks about those types of tradeoffs and how he sees the current balance of risk. The less he discusses these matters, we believe, the more cushion investors need to build into their pricing models, leading to inefficiencies and underperformance.

Policymaking is an art, not a science, and investors need to know if they’ve got Jackson Pollock or Diego Velázquez holding the brush.

Treasury constrained by economics

While Warsh’s problem, we believe, is the lack of clear speech and actions that align with that speech, U.S. Treasury Secretary Scott Bessent has certainly not been shy about acting. Most recently, he has announced bond repurchases – and boasts of a broad toolkit – to bring down long-term U.S. government bond yields. This move, we believe, is unlikely to achieve that goal and will serve largely to highlight the relative impotence of the U.S. Treasury acting alone.

Bond buying binge?

The attempt to shift yields lower took the form of a promise to “at least” double the size of U.S. Treasury bond buybacks to US$4 billion per operation with a focus on longer-term maturities. The announcement led to a sharp rally in U.S. government bonds, but the gains faded just as quickly with yields essentially reverting to their pre-intervention levels.

For a bond market intervention to be effective, in our opinion, it needs specificity: an impressive dollar amount, matched with a precise yield target.

Bessent’s Treasury announcement failed both tests.

First, there may have been a time when $4 billion was a lot, but not today. The U.S. recently passed $40 trillion in debt outstanding, so the buyback is lacking a zero or two to be impressive. Unnamed officials later floated the idea of using the Treasury’s General Account as a source of funds, but that is more of an accounting gimmick than a change in intervention size.

Second, there’s no clarity on price. If Bessent wants to put a line in the sand on yields, he needs to draw it, not just hint that it exists. A market participant today could buy a 30-year bond at a 5.3 percent yield relying on Treasury’s willingness to buy debt, only to find that the government’s appetite kicks in at much lower prices. That’s not attractive.

We’re well aware of Bessent’s background and his role in helping George Soros “break the Bank of England,” so he obviously knows a thing or two about failed market interventions. In our view, Bessent’s real policy goal is to slow the pace of any bond selloff rather than putting an end to it. By introducing the potential for sharp price rallies, Bessent’s tough talk could effectively limit the amount of leverage market participants can use to position for higher rates.

Fundamentals matter

While Bessent may be able to impact the speed of a rate rise, we believe the fundamentals will eventually reassert themselves. In our view, and as we’ve recently discussed, it’s no mystery why longer-maturity yields are high:

• Strong economic growth
• AI infrastructure borrowing
• Massive and growing federal debt
• Inflation concerns
• Political uncertainty

Long-maturity bond investors look for slow, steady growth, sound fiscal policy, central bankers who prioritize low inflation and a predictable political system. The way to achieve that sustainably is to reduce the supply of debt – most importantly by reducing the federal budget deficit – and increase demand for bonds by giving investors policy stability. Those are moves that are beyond Bessent’s power.

Fed not Feds

This is not to say that rates cannot be manipulated by government officials. The Fed does it literally every day to fix overnight yields.

Could the Fed do the same thing with long-term rates? Absolutely. If that institution wanted long-term yields at 4.5 percent, it could credibly come out and say it would buy any and all bonds at that level.

The consequence of such a move, however, would not just be lower rates but, we believe, a much lower U.S. dollar. The Fed would be showing a willingness to pump out large amounts of dollars to purchase longer-term bonds – simple supply and demand would indicate a potential drop in each dollar’s value relative to other currencies.

The signalling component of such a move would also, we believe, be highly negative for U.S. assets. Intervening to control long-term rates is arguably appropriate in a crisis, but this is not a crisis, rather just an inconvenience. If yields are high because of fiscal policy or inflation fears, credible officials should address the underlying cause, not try to shoot the market messenger.

The yield curve wants what it wants

Bonds – particularly those that go out 30 years – thrive on credibility, commitment and predictability. If market participants have a high degree of confidence that policymakers mean what they say and will stay in it for the long haul, they are more willing to lend money for decades at a time. Without that credibility – or if the credible commitment is to fiscal profligacy and artificially low rates – investors have no choice but to demand higher rates.

Nothing in the toolkit, we believe, will change that underlying reality.

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