Scott Bessent believes deleveraging drives the U.S. Treasury market downturn

Treasury Secretary Scott Bessent said the recent decline in the U.S. Treasury market was driven by deleveraging, not foreign selling.

Bessent pointed out that there was increased foreign demand in 10-year and 30-year Treasury bonds in recent auctions, noting that there was no immediate need for action. He disclosed that the Treasury had tools to mitigate the situation, including scaling up buybacks if necessary.

Bessent also dismissed the recent selloff in the bond market, rejecting speculation that foreign nations were dumping their holdings of U.S. Treasuries. Instead, Bessent interpreted the decline in the Treasury market as mainly a product of deleveraging, nothing systemic.  

The former hedge fund manager also said that one lesson from his career was not to look at what happened over a week. He explained that looking at the trading history provided better insights, citing the 1998 bust of Long Term Capital Management, which he claimed had ‘nothing to do with anything’ other than investors acting with excessive leverage. 

Bessent attributes the  U.S. Treasury market decline to ‘normal deleveraging’

The Treasury Secretary also denied that chaos in the bond market over the deleveraging of basis trades forced President Trump to pause his global trade tariffs for 90 days. On the contrary, Bessent said this was Trump’s plan all along.

Some market watchers warned of a forced unwinding of the popular basis trade strategy in which hedge funds profited by exploiting the difference between Treasury futures and Treasury bond prices. However, the Morning Star noted that this strategy depended on relatively stable bond market prices.

“I’ve seen it very often in my market career – one of these deleveraging convulsions is going on right now in the markets, and I think it’s in the fixed-income market. Some very large leverage players are experiencing losses and have to deleverage.” – Scott Bessent 

Former Treasury Secretary Janet Yellen also agreed that ‘highly leveraged hedge funds’ had to sell, causing instability in the Treasury market. However, economist Larry Summers, who served as Treasury Secretary in the Clinton administration, said the U.S. was likely headed for a serious financial crisis entirely driven by U.S. government tariff policy. Others argued that different factors related to leveraged positions were at play.

Brusuelas blames the recent Treasury market turmoil on the basis trade

According to the chief economist at tax consultancy RSM Joseph Brusuelas, the origin of the shock across the Treasury market was the inept rollout of the ‘basis swaps’ trade. He claimed that the loss of credibility and confidence in the current U.S. regime and behavior across financial markets reflected that.

As per CNBC, issues causing the jump in yields were ‘multipronged’ but all related to dislocations brought on by, among them, the unwinding of a popular trade that involved swapping floating-rate products such as Treasurys for a futures product like the Federal Reserve’s Secured Overnight Financing Rate, especially by traders looking to pocket the difference between the rates in ‘basis swaps’ trade. 

Brusuelas emphasized that right now, the unwinding of the basis swaps trade was the primary reason, but not the sole source, of the increase in yields across the Treasury curve. Funds had to raise ‘prodigious quantities of cash’, which resulted in the selling of Treasurys.

The rise in Treasury yields often closed the gap and reduced profit opportunities or caused losses, but the situation was even more complicated when hedge funds used leverage for the trades, leading to margin calls and the need for quick cash, which was often obtained by selling government debt. 

Another reason cited for the bond market sell-off was the Trump administration’s efforts to ‘knock down’ the trade deficit of roughly $800 billion. While the goal in reducing the deficit was to open up the market for U.S. goods and services, it also had a knock-on effect that could affect bond yields.

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