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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Key Takeaways
- Treasury’s Credibility Crisis:Unscheduled interventions by the US Treasury, including bond buybacks and attempts to manage currency markets, are being perceived by investors as desperate measures. Instead of reassuring, these actions are undermining market confidence and signaling underlying systemic weakness rather than strength, fueling a critical loss of trust among essential bondholders.
- Erosion of Safe-Haven Status:The simultaneous weakening of US Treasury bonds and the dollar represents a significant and concerning decline in global investor trust in these core assets as traditional safe havens. This loss of confidence is driving capital towards alternative stores of value like gold and the Swiss franc, challenging the foundational role of US assets in the global financial system.
- Global Ripple Effect & Fed’s Dilemma:Rising US borrowing costs and currency volatility threaten to inflate global borrowing expenses for other nations and complicate the Federal Reserve’s monetary policy decisions. This situation places Fed Chair Kevin Warsh in a challenging position to restore stability at the upcoming Jackson Hole symposium without further unsettling already nervous markets.
Scott Bessent’s running battle with the bond market is starting to look like his boss’s war in Iran — started by his own hand with a tangled set of objectives, an underestimated opponent and an implausible path to victory. And like the conflict in the Middle East, we are all going to suffer its effects. The stakes in this financial confrontation are immense, potentially reshaping global capital flows and the very architecture of international finance, impacting everything from corporate borrowing to national debt servicing.
The latest skirmish came on Wednesday when, in an unscheduled announcement, Bessent’s US Treasury department announced that it would double the pace at which it buys back its own long-term bonds. While buybacks in themselves are a pretty standard bit of financial housekeeping, often used to manage liquidity or smooth out supply, to bond market wonks, a few things stuck out, prompting serious concern about the Treasury’s underlying motives and the health of the market.
One is the unscheduled nature of this move. Painstaking predictability is the name of the game in dealing with the $32tn US government bond beast, particularly with the longer maturities that institutional investors depend on for duration management and risk modelling. Bond investors, especially large pension funds, insurance companies, and sovereign wealth funds, abhor surprises. They often interpret such unexpected support measures as an admission that something somewhere has broken, that market liquidity has dried up, or that the Treasury perceives a fundamental imbalance. This perception alone can trigger a flight to quality *away* from Treasuries, ironically exacerbating the very conditions the buybacks aim to alleviate by signaling distress rather than control.
The other is the context, because this is just the latest in a series of surprises Bessent has delivered in the most important financial market on earth, each move seemingly designed to address a symptom rather than the underlying fiscal malaise.
Three weeks ago, of course, he inserted himself in the market for the Japanese yen, of all things, buying the currency to prop it up in what was painted as a friendly act of solidarity with an ally in need. Japan, a major global creditor and holder of vast sums of US Treasuries, has been grappling with persistent yen weakness, primarily driven by its ultra-loose monetary policy diverging sharply from the Fed’s tighter stance. A weaker yen incentivizes Japanese investors to repatriate capital for better returns, potentially involving the sale of US debt, which would flood the market and put significant upward pressure on US yields.
The link back to Treasury bonds may not be immediately obvious to the layperson, but bond market insiders are not buying the friends-helping-friends explanation. Instead, they widely see it as an effort to stop Japan from fixing its yen problem by selling down its gigantic stash of US debt. Such a move by Japan, holding over $1.1 trillion in Treasuries, would unleash an enormous supply shock, causing yields to spike further and significantly increasing US borrowing costs across the board. The icing on the cake: Bessent said any future yen interventions will use a highly unusual facility — crucially, one designed explicitly to avoid the immediate sale of Treasury bonds, underscoring the Treasury’s desperate bid to insulate its own market from external pressures and avoid further supply-side disruptions.
So now, no fewer than three times in three weeks, Bessent has given the message to investors to please stop selling his bonds. But they are selling his bonds anyway, taking borrowing costs to extraordinary heights. The benchmark 10-year Treasury yield, a global bellwether, has climbed significantly, reflecting deep investor skepticism about US fiscal sustainability and the Treasury’s ability to manage its burgeoning debt load. This comes in the same week the US national debt crossed the $40tn line for the first time, a psychological and fiscal threshold that amplifies market anxieties. Worse, investors are now selling the currency too — the dollar took a sizeable hit after the buybacks announcement, from which it has not recovered, signaling a broader decline in confidence in US assets and a potential shift in global capital flows.
Bessent’s reaction has been to offer yet more support for long-term bonds, to suggest runaway economic growth will magic all the debt away, and to tell the bond market it is wrong and failing to reflect fundamentals. This dismissive stance, rather than fostering trust, alienates sophisticated institutional investors who base their decisions on hard data, risk assessments, and macroeconomic trends, not political assurances. Investors will be keen to see his promise of tighter fiscal spending bear fruit quickly, as mere rhetoric will do little to sway a market increasingly focused on deficit trajectories and the long-term solvency of the US government.
It is worth keeping in mind that poor trading conditions typical of August, often characterized by thinner liquidity as many traders are on holiday, amplify all sorts of stresses. Some odd distortions are also in play, including the effect of massive long-term debt issuance by Big Tech companies. These mega-cap firms, capitalizing on still-relatively-low borrowing costs, are issuing huge tranches of long-dated corporate bonds, which directly competes for institutional funds typically destined for global government debt. Pension funds and insurance companies, needing long-duration assets, might opt for higher-yielding corporate paper over Treasuries. Investors say some government borrowers in Europe have even altered the timing of their own deals to try and dodge the impact of these vast tech transactions, illustrating the profound demand-side pressures. The annual rush of new bonds this September, with both government and corporate supply expected to surge, could lead to significant market indigestion and further yield volatility.
Niggly factors like this aside, though, investors know that a market experiencing weakness in its bonds and its currency at the same time is one in a very tricky spot. This “twin deficits” dynamic – a deteriorating fiscal situation combined with a weakening currency – is a classic sign of declining economic confidence and can presage more serious financial instability. As a combination, it reflects a broad decline in confidence in both the nation’s economic management and its ability to service its debt. Bessent is lucky that, so far, stocks have been insulated from the fallout thanks to bumper earnings at US companies, but this decoupling cannot last indefinitely if the cost of capital continues to rise for the broader economy.
But bear in mind that Treasuries and the dollar are the world’s pre-eminent safe assets — by tradition, bolt-holes in times of stress, fundamental pillars of global financial stability. Now the stress is pushing them down, while gold and the Swiss franc are climbing as investors seek shelter elsewhere. This shift signals a profound re-evaluation of risk and the perceived reliability of US assets. The long-running fissures in the status of core US assets are widening, and confidence in their ability to act as a haven, a bedrock for global capital, is in stark decline. This has significant implications for global reserve asset allocation and the future of the dollar’s dominance in international trade and finance.
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Emerging market specialists, still bearing the scars of Turkey’s tussle with its bond and currency markets nearly 10 years ago, are cracking a wry smile, recognizing a familiar pattern of government intervention clashing with market reality. For UK government bond veterans haunted by the Liz Truss disaster of 2022, where unfunded tax cuts triggered a dramatic sell-off in gilts and a run on pension funds, Treasuries are starting to look like gilts in an expensive suit and with good teeth – a stark warning of how quickly market sentiment can turn against even the most established economies when fiscal credibility is questioned.
So far, US projections of strength have been interpreted as expressions of weakness. This is unfortunate, as the implications extend far beyond US borders. If Treasury yields keep rising, other countries will end up paying more to borrow too, as US yields act as a global benchmark for risk-free rates. This export of higher borrowing costs can stifle global economic growth, exacerbate debt challenges in highly indebted nations, and complicate monetary policy decisions for central banks worldwide.
This means the task falls to Kevin Warsh, chair of the Federal Reserve, to try and steady the ship at the Jackson Hole economic symposium in a few days’ time. This would be tricky for anyone, but particularly for someone whose stated preference is to say less and let the markets, which Bessent says are misfiring, do the work for him. The Fed’s independence and clear, consistent communication are paramount in such times, yet Warsh faces the unenviable task of navigating between fiscal challenges and monetary policy expectations, all while preserving the Fed’s credibility.
The fact that Treasuries are at the moment behaving more like gilts than like rock-solid superpower bonds makes this even harder. A hint at interest rate cuts — usually a boost to Treasuries by reducing future borrowing costs — would weaken the bonds still further in this new regime, even if it pleased President Donald Trump. In a climate where fiscal profligacy is already a concern, cutting rates could be interpreted by markets as enabling more government spending without consequence, thereby undermining confidence in the dollar and fueling inflationary expectations, pushing long-term yields even higher despite short-term rate cuts.
The effort under way today to boss markets around and tell them they are wrong is not having the desired effect. Honestly, it never does. A course correction to shore up confidence, anchored in transparent fiscal responsibility, a credible plan for debt reduction, and predictable policy communication, is desperately needed before the tremors in the world’s most vital financial market escalate into a full-blown crisis with global ramifications.
Market Impact
The current instability in the US Treasury market and the weakening dollar are poised to have significant and far-reaching market impacts across various asset classes. For fixed income, expect continued volatility and upward pressure on yields across the curve, not just for US Treasuries but also for corporate bonds and global sovereign debt, as the US yield acts as a fundamental benchmark. This will translate into higher borrowing costs for businesses and consumers worldwide, potentially slowing economic growth and investment. In currency markets, the dollar’s safe-haven status will remain under threat, leading to further depreciation against major currencies and traditional stores of value like gold and the Swiss franc. This could impact corporate earnings for multinational companies, shift global trade dynamics, and potentially lead to imported inflation for the US. While equities have been largely resilient due to strong corporate earnings, rising discount rates from higher bond yields could eventually weigh on valuations, particularly for growth stocks with future earnings far out. A broader decline in market confidence could trigger a significant risk-off sentiment, pushing investors into defensive assets or out of the market entirely. Policymakers globally will be under increased pressure to manage their own economies in the face of US fiscal uncertainty and potential capital flight from dollar-denominated assets, potentially leading to more fragmented and less predictable global financial markets.
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