Bessent's Test in the Bond Market: Can the US Calm Investors?

US Treasury Secretary Scott Bessent has emerged as an important asset for Donald Trump as he helped calm market fears that arose due to the president's policies. However, he now faces his toughest test as he confronts investors in the $32 trillion US Treasury bond market, who are concerned that the war in Iran is pushing government spending and inflation higher.

The sharp declines recently recorded in long-term US debt did not, according to Bessent, reflect "fundamental economic foundations." In an interview he gave on Thursday to CNBC, he blamed "poor" liquidity for the volatility. While oil prices are rising and the war in Iran shows no signs of ending soon, these are the actions Bessent is taking to calm the bond market.

What is the big bet Bessent is making?

His main goal is to stem the sell-off of long-term debt, such as government bonds maturing in 10 or 30 years, which have pushed US government borrowing costs to their highest levels in years. Yields usually rise when bond prices fall, and this move has triggered a broader rise in interest rates on everything from corporate debt to mortgages, just months before the midterm elections in November.

On Wednesday, the Treasury rushed to announce that it intends to "double" its purchases of long-term government bonds from $2 billion to at least $4 billion. These buybacks have been used in the past to fix minor plumbing issues in the bond market, but have not been a macro-level tool to control yields. The increased purchases will begin in early September and end in November. Bessent also hinted that further interventions might be possible if the $4 billion in purchases are not enough, saying the Treasury has a "large toolkit."

How will the Treasury pay for this?

However, the tools available to the Treasury — unlike those of the Central Bank — do not give Bessent unlimited power to create capital. Unlike the Fed, the Treasury cannot start buying trillions of dollars worth of bonds, an approach often referred to as "quantitative easing" that bends the yield curve and keeps borrowing costs low.

The Treasury has not yet released how it intends to fund the purchases. But its only real way to pay for long-term bond purchases is to raise capital by selling short-term bonds. Accordingly, it is estimated that the Treasury intends to issue short-term bonds soon. This assessment flattened the yield curve by raising borrowing costs on three-month and six-month bonds. The likely strategy of buying long-term bonds and issuing short-term bonds has drawn comparisons to the Federal Reserve's "Operation Twist" in 2011, where the Central Bank used the proceeds from the sale of hundreds of billions of dollars in short-term securities to purchase long-term government bonds. The Fed's operation helped lower long-term borrowing costs at a time when interest rates were already near zero, and it was far more extensive than Bessent's intervention.

Will the plan work?

While yields on 30-year bonds fell after Wednesday's announcement, most of those declines were wiped out the very next day. Thus, the yield on the 10-year benchmark bond, which sets the price of long-term loans across the US economy, reversed. Analysts argued that a number of factors — from the massive US fiscal deficit to competition for capital from AI companies and the economic fallout from the war in Iran — are pushing US borrowing costs higher.

"Bond buying can achieve targeted goals, but it cannot change the trajectory of the debt," said Dec Mullarkey of SLC Management. "Bond markets are pricing in the growing fiscal risks."

There are also those who estimate that this direct intervention by Bessent in the bond market to influence borrowing costs could itself trigger further bond sales, which would raise yields even higher. "Some investors might think that if the administration is taking back control of the yield curve, then perhaps the administration thinks inflation will rise and stay high for a while," said Michael Strain, director of economic policy studies at the American Enterprise Institute. "This will put additional pressure on long-term bond yields."