A
reminder of that fragility came on November 5 when the Treasury
Department signaled it was considering selling more long-term debt. The
same day, the Supreme Court began hearing arguments over the legality of
Trump's sweeping trade tariffs. Benchmark 10-year bond yields, which
have fallen steeply this year, spiked more than 6 basis points – one of
the biggest jumps in recent months.
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With
the market already uneasy about the size of U.S. federal deficit, the
Treasury proposal stirred fears among some investors of upward pressure
on long-dated bond yields. The Supreme Court case, meanwhile, raised
doubts about a major source of revenue to service the $30 trillion pile
of government debt held by the market.
Citigroup analyst Edward Acton called the moment “a reality check" in a November 6 daily report.
Reuters
spoke to more than a dozen executives at banks and asset managers
overseeing trillions of dollars in assets who said that beneath the
relative calm of bond markets in recent months a battle of wills is
playing out between the administration and investors concerned about the
persistently high U.S. deficit and debt levels.
Reflecting those worries, the so-called "term premium” - the extra yield investors demand for holding U.S. debt for 10 years - has once again started to rise in recent weeks.
“Bond
markets’ ability to terrify governments and politicians is second to
none, and you've seen that in the U.S. this year,” said Daniel
McCormack, head of research at Macquarie Asset Management, referring to
April’s bond crash which forced the administration to temper its plans
for tariff increases.
Over
the long term, the failure to resolve strains on public finances can
create political issues as voters grow "persistently disappointed with
government delivery," McCormack said.
Treasury
Secretary Scott Bessent – a former hedge fund manager - has repeatedly
said he is focused on keeping yields down, especially on the benchmark
10-year bond, which affects the cost of everything from the federal
government’s deficit to household and corporate borrowing.
"As
Treasury Secretary, my job is to be the nation's top bond salesman. And
Treasury yields are a strong barometer for measuring success in this
endeavor," Bessent said in a November 12 speech, noting borrowing costs
were down across the curve. The Treasury did not respond to a request
for comment for this story.
Such
public messaging and behind-the-scenes interactions with investors have
convinced many in the market the Trump administration is serious about
keeping yields in check. Some unwound bets over the summer that bond
prices would fall after the Treasury proposed increasing purchases under
an ongoing buyback program meant to improve market functioning, data
shows.
The
Treasury has also discreetly sought investors' opinions on major
decisions, with one person familiar with the matter describing them as
"proactive."
In
recent weeks, the Treasury consulted with bond investors on five
candidates for the Federal Reserve chair role, asking how the market
would react to them, the person said. They were told it would react
negatively to Kevin Hassett, director of the National Economic Council,
because he is not perceived as independent enough from Trump.
Several
investors said they believed the Trump administration has merely bought
itself time with such steps and, with the U.S. still needing to finance
an annual deficit of around 6 percent of GDP, risks remain to peace in
the bond market.
The administration is keeping bond vigilantes - investors who punish government profligacy by driving up yields - at bay, but only just, these market experts said.
Price
pressures from tariffs, bursting of an artificial intelligence-led
market bubble, and the prospect of an overly accommodative Fed pushing
inflation higher could all upset the equilibrium, investors say.
"The
bond vigilantes never go away. They're always there; it's just whether
they're active or not," said Sinead Colton Grant, chief investment
officer at BNY Wealth Management.
THE VIGILANTES ARE WATCHING
White House spokesman Kush Desai told Reuters the administration was committed to ensuring robust and healthy financial markets.
"Cutting
waste, fraud, and abuse in runaway government spending and cooling
inflation are some of many actions by this Administration that have
increased confidence in the U.S. Government's finances and reduced
10-year Treasury yields by nearly 40 basis points in the past year," he
said.
The
bond market has a history of punishing fiscally irresponsible
governments, sometimes costing politicians their jobs. Most recently, in
Japan, Prime Minister Sanae Takaichi has grappled with keeping bond investors happy while trying to further her agenda.
When
Trump began his second term, several indicators watched by bond traders
were flashing red: total U.S. government debt stood at over 120% of
annual economic output. Those worries flared after April 2 when Trump
imposed massive tariffs on dozens of countries.
Bond
yields - which move inversely to prices - saw their steepest weekly
rise since 2001, as bonds sold off alongside the dollar and U.S. stocks.
Trump backed off, delaying the tariffs and ultimately imposing them at
rates below what he initially proposed. As yields retreated from what he
described as a queasy moment, he hailed the bond market as "beautiful."
Since
then, 10-year Treasury yields have fallen over 30 basis points, and a
measure of bond market volatility has recently fallen to its lowest in
four years. On the surface, it seems that bond vigilantes have gone
silent.
SIGNALS TO THE BOND MARKET
One
reason for the silence, the investors said, is the resilience of the
U.S. economy, with massive AI-led spending offsetting the drag on growth
from tariffs, and with a Fed in easing mode because of a slowing job
market; another is the steps the Trump administration has taken that
signal to the market that it doesn’t want runaway yields.
On
July 30, the Treasury said it was expanding a buyback program that will
reduce the amount of long-dated, illiquid debt outstanding. The
buybacks are meant to make it easier to trade bonds, but because the
expansion was focused on 10-, 20- and 30-year bonds, some market
participants wondered whether it was an effort to cap those yields.
The
Treasury Borrowing Advisory Committee, a group of traders who advise
the agency on debt, said there was "some debate" among its members
whether it could be "misconstrued" as a way to shorten the average
maturity of outstanding U.S. government bonds. The person who is
familiar with the matter said some investors worried about the Treasury
taking unconventional steps, such as an aggressive buyback program or reducing the supply of long-dated bonds, to limit yields.
As
these discussions were going on over the summer, short positions – bets
that long-dated Treasury bond prices would fall and yields would rise –
fell, data shows. Short bets against bonds with at least 25 years of
remaining term to maturity fell sharply in August. They have been
ramping back up in the past few weeks.
"We're
in this age of financial repression with governments using various
tools to artificially keep a lid on bond yields," said Jimmy Chang,
chief investment officer of the Rockefeller Global Family Office, part
of Rockefeller Capital Management, which manages $193 billion in assets,
calling it an "uneasy equilibrium".
The
Treasury Department has also taken other steps to support the market,
such as leaning more heavily on short-term borrowing through Treasury
bills to fund the deficit instead of increasing supply of long-dated
bonds. It has also called on banking regulators to make it easier for
banks to buy Treasury bonds.
JPMorgan
analysts have estimated that the supply of U.S. government debt issued
to the private sector with a maturity longer than one year would decline
next year compared to 2025, even if the U.S. budget deficit is expected
to remain roughly unchanged.
Demand for T-bills is expected to get a boost as well. The Fed has ended its balance sheet rundown, meaning it will be again an active buyer of bonds, particularly short-dated debt.
And
the Trump administration’s embrace of cryptocurrencies has created a
new significant buyer of such debt – stablecoin issuers.
Bessent
said in November that the stablecoin market, valued at around $300
billion, could grow tenfold by the end of the decade, increasing demand
for Treasury bills.
"I
feel like there's less uncertainty in the bond market; there's just
more equalization in terms of supply and demand," said Ayako Yoshioka,
portfolio consulting director at Wealth Enhancement Group. "It's been a
little odd, but it's worked so far."
The
question for many market participants, however, is how long it can
last. Meghan Swiber, senior US rates strategist at BofA, said the bond
market's current stability relied on a "tenuous balance" of subdued
inflation expectations and Treasury's reliance on shorter-maturity
issuance, which has helped keep supply concerns in check.
If
inflation surges and the Fed turns hawkish, she said, Treasuries could
lose their diversification appeal, rekindling demand concerns.
The reliance on T-bills to fund the deficit also has risks, and some sources of demand such as stablecoins are volatile.
Stephen
Miran, the head of the White House Council of Economic Advisers who is
currently serving as a Fed governor, criticized the Biden administration
last year for the same approach Bessent is taking now: leaning on
T-bills to fund the deficit. Miran argued at the time that it meant the
government was piling up short-term debt that it might have to refinance
at much higher costs if interest rates suddenly spike.
When
reached for comment, Miran, who as Fed governor has been voting for the
central bank to aggressively cut rates, declined to comment beyond
referring Reuters to a September speech in which he forecast that national borrowing would decline
Stephen
Douglass, chief economist of NISA Investment Advisors, said the
currency depreciation and spike in yields in the aftermath of Trump's
April tariff announcement was something that's typically seen only in
emerging markets, and it spooked the administration.
"It has been a meaningful constraint," Douglass said.
Reporting by Davide Barbuscia; Additional reporting by Vidya Ranganathan; Editing by Paritosh Bansal and Daniel Flynn
Our Standards: The Thomson Reuters Trust Principles.
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