Federal Reserve Chairman Kevin Warsh has promised that the U.S. central bank will deliver price stability, but Treasury Secretary Scott Bessent's decision on Wednesday to double buybacks of longer-dated U.S. debt may complicate any effort to do so.
On Wednesday, the Treasury Department announced that it was doubling the size of its effort to buy back Treasury securities with maturities between 10 and 30 years, to $4 billion per operation. The government announced this as long-dated Treasury borrowing costs have been moving up sharply, negatively impacting credit affordability in the global economy generally.
The Treasury announcement helped bring yields, which move inversely to prices, down in trading that followed the announcement.
Its action has generated questions as to whether the Fed or the Treasury is now the bigger influence on general credit conditions.
"Given Warsh’s desire to say less and [Treasury Secretary Scott] Bessent’s actions today, the center of gravity could be moving from the Fed to the Treasury. We’ll have to see if this continues because it would be a big change for traders," said David Russell, global head of market strategy at TradeStation.
Since the global financial crisis two decades ago the central bank has used asset buying to calm markets and to lower long-term borrowing costs. The rise in Treasury bond yields has been jarring to market observers and has raised questions as to whether the situation is extreme enough for the Fed to get involved, even as there are lots of questions about the longer-term potency of the new Treasury buyback schedule.
Warsh has long expressed skepticism over using central bank asset buying as a policy tool, and has made as a cornerstone goal getting what is now a $6.8 trillion balance sheet lower. But he has also signaled a willingness to work with the Treasury and coordinate where possible, which might make the Fed leader more open to link up with the Treasury despite his broader disdain for large Fed holdings.
How Warsh could act is further complicated by his near blanket refusal to explain what he thinks lies ahead for monetary policy and his unwillingness to provide much guidance on how he looks at data to reach policy decisions.
HIGH BAR
Thus far, market participants don’t see a case for Fed involvement.
“The bar for the Fed to step in with market-stabilizing purchases is very high at the moment and we would need to see signs of liquidity deteriorating enormously and signs of market dysfunction, which we're simply not seeing,” said Gennadiy Goldberg, Head of U.S. Rates Strategy at TD Securities.
Most importantly, the market is functioning in a way that the Fed can still manage its interest rate target range, which meeting minutes from the late July Federal Open Market Committee, released Wednesday, affirmed is the central bank’s main tool to achieve its job and inflation mandates.
“I don’t see any impact on the Fed's ability to control short-term interest rates,” said Michael Feroli, chief U.S. economist at J.P. Morgan.
The range of debt targeted by the Treasury increased buyback operation is very influential to real world borrowing costs for things like mortgages and corporate borrowing. Borrowing costs for the long bond hit nearly a two-decade high amid concerns about inflation, government borrowing appetites, and as the Treasury faces competition from the offerings from companies furiously building out infrastructure for artificial intelligence.
Presumably Fed asset buying could lower those yields or cap their rise, and it would have more firepower to devote to the matter than the Treasury. But as it would be akin to an easing of monetary policy and that would be hard to square against the Fed’s ongoing efforts to lower inflation that still stands well above the 2% target.
Daleep Singh, chief global economist at PGIM, who also served at the New York Fed and Treasury Department, said what the Treasury has done ultimately doesn't change the story driving yields up and while its action is shining a spotlight on a real issue it is doing so "without a credible strategy to solve" the issue.
SHRINKAGE
The size of Fed holdings matters to Warsh because he believes the Fed owns too many bonds and that those holdings distort financial market pricing. He wants the Fed to own fewer bonds but has said that will take time to achieve that given the complexity of the issue.
At the June FOMC meeting he announced a series of task forces weighing Fed issues and one of them was devoted to tackling Fed balance sheet issues.
There is broad speculation the Fed may be able to get its holdings smaller by changes in banking rules that would permit banks to hold less emergency liquidity, though some fear that could increase financial stability risks and force the Fed to intervene more often in times of stress.
