The Fed's tightening logic faces challenges! Waller wants long-term bonds to "replace the interest rate hikes by the central bank," while Bostic's repurchase disrupts the layout.

As Federal Reserve Chairman Kevin Walsh works to restore price stability by reducing a $6.8 trillion balance sheet, Treasury Secretary Scott Bethencourt's urgent moves are causing a rare "misalignment" in direction between the two sectors. On Wednesday, the U.S. Treasury announced it would at least double the scale of liquidity support repurchase operations for 10 to 30-year Treasury bonds, increasing the per-repurchase cap from $2 billion to at least $4 billion. Following the announcement, the yield on 10-year U.S. Treasuries fell by 6 basis points to 4.65%, while the 30-year yield dropped nearly 10 basis points to 5.18%just a day after the 30-year yield had reached 5.337%, the highest since April 2007. This seemingly technical adjustment has sparked a fierce debate on Wall Street regarding who is leading credit conditions. TradeStation's Global Market Strategist David Russell remarked, Given Walsh's reluctance to speak, and Bethencourt's actions today, the focus may be shifting from the Fed to the Treasury. This is a significant change for traders. Bethencourt's historic turn: from predictable to most interventionist The U.S. Treasury announced it would raise the upper limit of liquidity support repurchase operations for 10 to 20-year and 20 to 30-year nominal coupon Treasury bonds from $2 billion to at least $4 billion, to take effect on September 9 and continue until November 4, the end of the current refinancing quarter. The Treasury's bond repurchase plan is not a new conceptit was reintroduced in 2023 to improve liquidity in the old bond market. However, this situation is markedly different. Just two weeks prior, the Treasury published its quarterly refinancing report. Wednesdays urgent adjustment indicates that officials are uneasy about the surge in 30-year Treasury yields to a 19-year high. John Briggs, head of U.S. interest rate strategy at Natixis, noted that if this plan had been announced during a routine refinancing report, the market reaction would not have been as intense; however, the timing of this announcement suggests that officials are not happy with what was happening at that moment. Bethencourts intervention is not an isolated incident. Over the past month, he has taken a series of decisive steps: he participated in the first U.S.-Japan joint intervention in the yen since 1998 at the end of last month; subsequently adjusted forward guidance in the quarterly bond issuance policy statement to pave the way for a potential reduction in long-term Treasury issuance; and this Wednesday launched a major offensive with the doubled repurchase. A team led by Jason Williams at Citigroup stated, In our view, this move aims to control long-end yields, rather than to maintain normal market operations. Aki Ohmori, chief fixed-income strategist at Deutsche Bank Japan, commented: The Treasury can buy back its own bonds, but it cannot buy back the dollar. He referred to Bethencourt as the most interventionist Treasury Secretary in decades and pointed out that this move marks a clear shift from the predictable debt management principles the Treasury has long adhered to. Ironically, Bethencourt criticized former Treasury Secretary Janet Yellen for taking a similar approach in 2024lowering long-term financing costs by increasing the issuance of short-term Treasury bills, arguing that this amounted to artificially influencing the market. Now he finds himself on this very path. Walsh's awkward position: Long bonds were just doing the Fed's work before being reversed by the Treasury The significant impact of Bethencourt's actions in Washington stems from their direct challenge to the carefully constructed policy logic of Walsh. Following the Federal Reserve meeting on July 29, Walsh frequently noted the sharply rising Treasury yields, suggesting that the Fed welcomed higher yieldsbecause this could raise borrowing costs through the market and tighten policy without the Fed needing to raise short-term rates. Wil Stith, senior bond portfolio manager at Wilmington Trust, succinctly stated, The market had previously concluded that since the long end of the bond market was doing the Fed's work, we didn't necessarily need to see an increase in the federal funds rate. Now, the Treasury Secretary's actions have somewhat reversed that situation. TradeStation's David Russell pointed out that this event might signify a fundamental shift in the balance of power: Given Walsh's reluctance to speak, and Bethencourt's actions today, the focus may be shifting from the Federal Reserve to the Treasury. Compounding Walsh's difficulties is his long-standing skepticism toward central bank asset purchases, making the shrinkage of a $6.8 trillion balance sheet a core goal. He argues for transforming the balance sheet from a routine policy tool into a crisis response tool, and the public interprets his long-term goal as reducing the current $6.7 trillion scale to approximately $3 trillion. Now, as the Treasury actively drives down long-end yields through repurchases, Walsh faces a profound paradox: he opposes Fed intervention in the market, but the Treasury's intervention is forcing the Fed to reconsider its rate path. Joseph Brusuelas, chief economist at RSM U.S., pointed out that the Treasury's actions make Walsh's task of bringing inflation back to 2% even more difficult. Walsh has consistently favored allowing the market to price rates naturally rather than through government intervention. The policy shackles of the Federal Reserve: Two opposing forces pulling in different directions Bethencourt's actions are pushing the Federal Reserve and the Treasury into direct policy opposition. The Federal Reserve and the Treasury are essentially working in opposite directions, Stith warned, I believe this will only force the Fedafter all, it has the larger toolboxto make more significant adjustments to the federal funds rate target. RSM Chief Economist Joe Brusuelas further pointed out that the Treasury's actions complicate Walsh's task of lowering inflation back to 2%Walsh has always preferred letting the market naturally price rates rather than government intervention. Before this, investors were indeed doing sorepricing long-term debt and demanding higher yields to hold U.S. Treasuries. If inflation stabilizes or continues to rise, the Federal Reserve will be forced to implement more aggressive rate hikes to counter the expansionary effects of the Treasury's yield suppression. Brusuelas bluntly stated, We are slowly heading toward a point where populist logic will demand central bank support for fiscal objectives. Currently, market participants believe the Federal Reserve has no reason to intervene directly. Gennadiy Goldberg, U.S. interest rate strategist at TD Securities, commented: The threshold for the Fed to engage in market stabilization purchases is extremely high; we need to see significant deterioration in liquidity and signs of market failure, and we are not seeing those signs at all. Michael Feroli, chief U.S. economist at JPMorgan, also believes this has no impact on the Fed's ability to control short-term rates. Temporary pain relief or Pandora's box? The repurchase's structural limitations: fundamental issues like inflation, deficits, and the AI debt issuance wave remain unresolved Wall Street experts are generally skeptical about the Treasury's ability to suppress bond yields over the long term, as the underlying factors pushing yields higher have not changed. Multiple factors are jointly driving up U.S. Treasury yields: the continuing expansion of the fiscal deficitthis fiscal year, the federal budget deficit is expected to reach $2.1 trillion; inflation remains above the Fed's 2% target; AI companies are issuing debt on a massive scalecompanies like Alphabet, Amazon, and Meta have issued nearly $220 billion in bonds this year, competing with government bonds for investors; and market skepticism regarding the Fed's independence. Krishna Guha, head of central bank strategy at Evercore ISI, commented: The immediate effects seem quite significant... but we doubt whether this operation can produce substantial effects over a longer period. Brusuelas was more straightforward: To sustainably lower bond yields, government spending must be reduced. Given the current economic framework both parties prefer, the chances of achieving this are virtually nonexistent. Therefore, Wednesday's action is nothing more than a temporary pain relief for the financial wounds we have inflicted upon ourselves. The fundamental factors pushing up U.S. Treasury yields have not changed: expanding fiscal deficits, inflation consistently above the Fed's 2% target, a weakening dollar, and tech companies issuing large amounts of bonds for data centers and other AI infrastructurethese corporate bonds are competing with government bonds for investors. JPMorgan strategists have even warned that the Treasurys sudden increase in bond repurchase scale could be seen by the market as lacking credibility, potentially leading to higher term premiums and elevated yields in the long run. Adding to the concern is the asymmetry of the operationexpanding repurchases is unlikely to prevent the rise of the term premium, while the extent of yield decline that can be achieved through repurchases will also decrease accordingly. The costs and effects of this operation may hinge on the Federal Reserves tacit decision to stay put. Once the Fed is forced to raise rates due to inflationary pressures, the Treasury's intervention effects will be completely negated. The ultimate test at Jackson Hole Stith pointed out that Bethencourt's actions have already opened a Pandora's box: How far does he intend to go in lowering long-term rates? The question is how much ammunition the Treasury Secretary will deploy to combat rising rates? Ultimately, what he can do is limited, far less than the Fed. He also raised the question of whether the Treasury would further raise the long-term Treasury bond repurchase scale to $8 billion after this repurchase. The direct test of this game will come at next week's Jackson Hole Global Central Banking Conference, where Walsh will deliver a keynote speech. At that time, the market will closely watch how this Federal Reserve Chair, committed to zero tolerance for inflation, will respond to the reverse operations from the Treasury. Meanwhile, Bethencourtwho claims to have a large toolboxwill continue down the path of lowering long-term rates. At the same time, Wells Fargo estimates that if the current increase persists, the scale of bond repurchases could reach $32 billion per quarter. In the context of U.S. debt approaching a record $40 trillion and a fiscal deficit maintaining a GDP ratio of 5% to 6%, this tug-of-war between the Treasury and the Fed is just beginning. Thresholds for Fed intervention: The market has not yet failed Although the surge in long-term yields has triggered widespread concern, the Federal Reserve currently has no reason to intervene. Gennadiy Goldberg, U.S. interest rate strategist at TD Securities, stated clearly: The threshold for the Fed to engage in market stabilization purchases is very high; we need to see significant deterioration in liquidity and signs of market failure, and we are not seeing those signs at all. The minutes from the late July FOMC meeting confirmed that the short-term interest rate target remains the central bank's main tool for achieving employment and inflation goals. Michael Feroli, chief U.S. economist at JPMorgan, also believes: I dont see how this would affect the Feds ability to control short-term rates.