Treasury

Bond Market Blows Off Treasury Bond Buyback; Gold and Bitcoin Soar

Scott BuchananLeave a comment

Scott Bessent used to be a serious financial player. When he was with George Soros’s fund, he helped them make a billion dollars in 1992 by betting against the British pound, and $1.3 billion in 2013 with a bet against the Japanese yen. He also ran his own hedge fund, with as much as $5 billion under management. In 2023-2024 he hitched his wagon to the fortunes of Donald Trump, becoming a large campaign contributor and fundraiser. He was rewarded by being made Treasury Secretary. On January 27, 2025, the U.S. Senate voted to confirm Bessent’s nomination. (The same day, a man with multiple Molotov cocktails and a knife who intended to murder Bessent was arrested at the United States Capitol, an event seemingly lost in the noise of all the attempted assassination attempts against this administration).

The current administration has continued the policy of the previous administration of profligate peacetime federal deficit spending, some 6% of GDP annually, well above the 50-year average of about 3.8%. The only way to finance this spend is to sell more and more Treasury debt. But the more of that debt is out there, the more interest needs to be paid on it. By the mid-2030’s, interest payments will balloon to the point that they, plus mandatory transfer payments like Medicare/Medicaid/Social Security, will consume 100% of tax revenues, with nothing left for discretionary spending (including defense). Being the cabinet officer responsible for financing this mess now is sort of like being CFO of Lehman Brothers in 2008.

Which brings us to the ignominious market response to Bessent’s attempt at bond market intervention last week. As it has become more and more clear to the rest of the world that the U.S. has no intention of reining in its deficit, but instead hopes to deal with it by inflating away the value of the dollar, the market has started to demand greater compensation for holding long-term U.S. debt. If you are wondering why you now have to pay 6.65 % for a 30-year mortgage, wonder no longer. These high interest rates are making it all the more painful for Treasury to fund the deficit.

Secretary Bessent made a surprise announcement last Wednesday that his department would double its maximum purchase of older, less-liquid long-term bonds, from $2 billion per week to $4 billion. The stated purpose of this long-running buyback program is to retire hard-to-trade bonds and replace them with newer, more-liquid bonds. That’s fine, but this snap announcement shortly after its quarterly refunding plan broke with Treasury’s long-held strategy of making ‘regular and predictable’ announcements, and (together with statements by Bessant threatening further intervention) was widely seen as an attempt to talk down the long-term rates.

It worked for about one day. Long term yields initially dipped Wednesday morning by about 0.1%, but by Thursday they were about back to where they were before the announcement. Not only did traders realize the size of the intervention was far too small to move the enormous T-bond market (and would not net decrease T-bonds outstanding), but Treasury’s move became interpreted as a sign of desperation over funding the U.S. deficit. That vibe will not help bring down Treasury bond rates going forward. The value of the dollar dipped on world exchanges, while the price of alternatives such as gold and Bitcoin soared:

That is a chart of Bitcoin price in the past month. HODLers rejoice, the long crypto winter may be over…

Former Treasury Official Defends Decision to Issue Short Term Debt for Pandemic;  I’m Not Buying It

Scott BuchananLeave a comment

We noted earlier (see “The Biggest Blunder in The History of The Treasury”: Yellen’s Failure to Issue Longer-Term Treasury Debt When Rates Were Low ), along with many other observers, that it seemed like a mistake for the Treasure to have issued lots of short-term (e.g. 1-2 year) bonds to finance the sudden multi-trillion dollar budget deficit from the pandemic-related spending surge in 2020-2021. Rates were near-zero (thanks to the almighty Fed) back then.

Now, driven by that spending surge, inflation has also surged, and thus the Fed has been obliged to raise interest rates. And so now, in addition to the enormous current deficit spending,  that tsunami of short-term debt from 2020-2021 is coming due, to be refinanced at much higher rates. This high interest expense will contribute further to the growing government debt.

Hedge fund manager Stanley Druckenmiller  commented in an interview:

When rates were practically zero, every Tom, Dick and Harry in the U.S. refinanced their mortgage… corporations extended [their debt],” he said. “Unfortunately, we had one entity that did not: the U.S. Treasury….

Janet Yellen, I guess because political myopia or whatever, was issuing 2-years at 15 basis points[0.15%]   when she could have issued 10-years at 70 basis points [0.70 %] or 30-years at 180 basis points [1.80%],” he said. “I literally think if you go back to Alexander Hamilton, it is the biggest blunder in the history of the Treasury. I have no idea why she has not been called out on this. She has no right to still be in that job.

Unsurprisingly, Yellen pushed back on this charge (unconvincingly). More recently, former Treasury official Amar Reganti has issued a more detailed defense. Here are some excerpts of his points:

( 1 ) …The Treasury’s functions are intimately tied to the dollar’s role as a reserve currency. It is simply not possible to have a reserve currency without a massive supply of short-duration fixed income securities that carry no credit risk.

( 2 ) …For the Treasury to transition the bulk of its issuance primarily to the long end of the yield curve would be self-defeating since it would most likely destabilise fixed income markets. Why? The demand for long end duration simply does not amount to trillions of dollars each year. This is a key reason why the Treasury decided not to issue ultralong bonds at the 50-year or 100-year maturities. Simply put, it did not expect deep continued investor demand at these points on the curve.

( 3 ) …The Treasury has well over $23tn of marketable debt. Typically, in a given year, anywhere from 28% to 40% of that debt comes due…so as not to disturb broader market functioning, it would take the Treasury years to noticeably shift its weighted average maturity even longer.

( 4 ) …The Treasury does not face rollover risk like private sector issuers.

Here is my reaction:

What Reganti says would be generally valid if the trillions of excess T-bond issuance in 2020-2021 were sold into the general public credit market. In that case, yes, it would have been bad to overwhelm the market with more long-term bonds than were desired.  But that is simply not what happened. It was the Fed that vacuumed up nearly all those Treasuries, not the markets. The markets were desperate for cash, and hence the Fed was madly buying any and every kind of fixed income security, public and corporate and mortgage (even junk bonds that probably violated the Fed’s bylaws), and exchanging them mainly for cash.  Sure, the markets wanted some short-term Treasuries as liquid, safe collateral, but again, most of what the Treasury issued ended up housed in the Fed’s digital vaults.

So, I remain unconvinced that the issuance of mainly long-term (say 10-year and some 30-year; no need to muddy the waters like Reganti did with harping on 50–100-year bonds) debt would have been a problem. So much fixed-income debt was vomited forth from the Treasury that even making a minor portion of it short-term would, I believe, have satisfied market needs. The Fed could have concentrated on buying and holding the longer-term bonds, and rolling them over eventually as needed, without disturbing the markets. That would have bought the country a decade or so of respite before the real interest rate effects of the pandemic debt issuance began to bite.

But nobody asked my opinion at the time.

“The Biggest Blunder in The History of The Treasury”: Yellen’s Failure to Issue Longer-Term Treasury Debt When Rates Were Low

Scott Buchanan3 Comments

That extra $4 trillion or so that the feds dumped into our collective checking accounts in 2020-2021 – -where did it come from? Certainly not from taxes. It was created out of thin air, via a multi-step alchemy. The government does not have the authority to simply run the printing presses and crank out benjamins. The  U.S. Treasury sells bonds to Somebody(ies), and that Somebody in turn gives the Treasury cash, which the Treasury then uses to fund government operations and giveaways. In 2020-2021, the Somebody who bought all those bonds was mainly the Federal Reserve, which does have the power to create unlimited amounts of cash, in exchange for government bonds or certain other investment-grade fixed income securities.

What is causing a bit of a kerfuffle recently is public assessment of what sorts of bonds that Janet Yellen’s Treasury issued back then. Interest rates were driven down to historic lows in that period, thanks to the Fed’s monster “quantitative easing” (QE) operations. The Fed was buying up fixed income hand over fist: government bonds, mortgage securities, even corporate junk bonds (which was probably illegal under the Fed’s charter, but desperate times…). This buying frenzy drove bond prices up and rates down.

All corporate CFOs with functioning neurons and with BB+ credit ratings refinanced their company debt in that timeframe: they called in as much of their old bonds as they could, and re-issued long-term debt at near-zero interest rates. Or they just issued 5, 10, 20 year low-interest bonds for the heck of it, raising big war-chests of essentially free cash to tide them through any potential hard times ahead. And of course, millions of American homeowners likewise refinanced their mortgages to take advantage of low rates.

What about the federal government? Was the Treasury, under Secretary  Yellen, similarly clever? No, not really. Because there is little serious doubt that the U.S. government will be able to pay its debts (grandstanding government shutdowns aside), the government can always find takers for 20- and 30-year bonds, as well as shorter maturity securities. A mainstay of government financing is the 10-year bond. And in 2020-2021, the Fed would have consumed whatever kinds of bonds the Treasury wanted to sell, so the Treasury could have issued a boatload of long-term bonds.

It seems that the Treasury issued a lot of 2-year bonds, rather than longer-term bonds. If they had issued say ten-year bonds, the government would have had a decade of enjoying very low interest payments on that huge slug of pandemic-related debt. But now, all those 2-year bonds are being rolled over at much higher rates and thus much greater expense to the government. (Since the federal debt only grows, almost never shrinks, maturing earlier bonds are not simply paid down, but are paid by issuing yet more bonds).

Veteran hedge fund manager Stanley Druckenmiller (reported net worth: $6 billion) commented in an interview:

When rates were practically zero, every Tom, Dick and Harry in the U.S. refinanced their mortgage… corporations extended [their debt],” he said. “Unfortunately, we had one entity that did not: the U.S. Treasury….

Janet Yellen, I guess because political myopia or whatever, was issuing 2-years at 15 basis points[0.15%]   when she could have issued 10-years at 70 basis points [0.70 %] or 30-years at 180 basis points [1.80%],” he said. “I literally think if you go back to Alexander Hamilton, it is the biggest blunder in the history of the Treasury. I have no idea why she has not been called out on this. She has no right to still be in that job.

Ouch.

Druckenmiller went on:

When the debt rolls over by 2033, interest expense is going to be 4.5% of GDP if rates are where they are now,” he warned. “By 2043—it sounds like a long time, but it is really not—interest expense as a percentage of GDP will be 7%. That is 144% of all current discretionary spending.

Unsurprisingly, Yellen demurs:

 “Well, I disagree with that assessment,” Yellen said when asked to respond to the accusation during an interview on CNN Thursday night. She said the agency has been lengthening the average maturity of its bond portfolio and “in fact, at present, the duration of the portfolio is about the longest it has been in decades.”

According to Druckenmiller, this is not quite true. It does seem that of the federal bonds held by the public (including banks), the average maturity (recently as long as 74 months) has indeed been a bit longer than usual in the past several years. However, this ignores the huge amount of government bonds held at the Fed:

“The only debt that is relevant to the US taxpayer is consolidated US government debt,” Druckenmiller said. “I am surprised that the Treasury secretary has chosen to exclude $8 trillion on the Fed balance sheet that is paying overnight rates in the repo market. In determining policy, it makes no sense for Treasury to exclude it from their calculations.”

Druckenmiller makes an important point. However, how this plays out depends on how the Fed treats these bonds going forward. If the Fed keeps these bonds on its balance sheet, and buys the replacement bonds, there will be actually very little interest expense to the government going forward. The reason is that the Fed is required to remit 90% of its profits back to the Treasury, so the gazillions of interest payments on those bonds and their replacements will largely flow right back to Treasury. However, if the Fed continues with reducing its balance sheet, forcing the Treasury to go the open market to roll these bonds over, Druckenmiller’s dire warnings will prove correct.

Because of this enormous debt overhang and the ongoing need for the government to sell bonds, I do not expect interest rates to go down as low as 2021 or even 2019 levels, unless there is a financial catastrophe requiring the Fed to become a gigantic net buyer of bonds once again.