U.S. Treasury Secretary Scott Bessent's Plan to Calm the Bond Market Could Have Unintended Consequences for Fed Chair Kevin Warsh

U.S. Treasury Secretary Scott Bessent recently surprised the bond market by announcing that the Treasury would repurchase a larger amount of longer-duration bonds to ease longer-term yields, which have surged lately.

The announcement has received a lackluster response. Many believe the move is unlikely to constrain yields, while others are confused by the Treasury's decision. The yield on the 30-year U.S. Treasury bond has come off its highs after surging to 5.32% and was slightly below 5.19%, as of this writing (Aug. 25).

The move could have unintended consequences, particularly for Fed Chair Kevin Warsh.

U.S. Treasury Secretary Scott Bessent (center). Image source: The White House.

Bessent is trying to get long-term yields under control

The Treasury regularly repurchases outstanding Treasury bonds being held by investors and retires them. Before Bessent's announcement, the Treasury had been repurchasing about $2 billion of longer-dated Treasuries on a regular schedule, typically several times per month.

Bessent announced that the Treasury plans to expand this part of the program to at least $4 billion of longer-dated bond repurchases. "Part of it is signaling here and to show that we believe that the yields don't reflect the underlying fundamentals," Bessent told CNBC on Aug. 20.

What seemed to catch many experts off guard was that Bessent announced the plans two weeks after the Treasury's quarterly refunding announcement, the time when the Treasury would typically announce changes like this.

The market can be incredibly sensitive to seemingly minor changes by the Treasury or the Fed because it might hint at a broader trend or event.

Furthermore, CNBC, citing anonymous sources, reported on Aug. 24 that the Treasury could fund such repurchases from its $1 trillion general account, perhaps suggesting it wouldn't have to issue new bonds, as investors may have assumed.

This could have a more powerful effect in reducing supply, which would drive up demand and, in turn, long-term bond prices, sending yields lower. Still, much is unclear about how the plan will proceed, and the Treasury could still issue new bonds to fund the repurchases.

How can Warsh be a hawk when this is happening?

When Kevin Warsh became the new chair of the Federal Reserve's Board of Governors this year, the big debate was whether he would be hawkish and in favor of interest rate hikes to stamp out persistent inflation or dovish.

Warsh has been clear that he wants to shrink the Fed's balance sheet over time, a hawkish stance. But he was also nominated by President Donald Trump, who greatly desires interest rate cuts.

Meanwhile, Warsh has confused the market in his first few Federal Open Market Committee (FOMC) meetings. On one hand, Warsh has repeatedly said that he believes prices are too high and that the Fed will rein in inflation.

However, Warsh has also said that he prefers to measure inflation differently from how the Fed measures it now. The method he's discussed, the "trimmed average" approach, would actually indicate inflation is lower than under the current methods.

Bessent's expanded repurchase program makes it harder for Warsh to be a hawk because raising the Fed's overnight borrowing rate, the federal funds rate, could very well put upward pressure on long-term yields, which the federal funds rate influences.

Shrinking the balance sheet could also put upward pressure on long-term yields, although Warsh is unlikely to do much on this front in the near term. Bessent's move could also undercut Warsh, according to EY-Parthenon chief economist Gregory Daco.

"There is a risk, if you extend this thought process, that we have entered into an environment of fiscal dominance, where essentially the Fed is taking its instruction from the Treasury and delivering upon a desired outcome of lower long-term interest rates," Daco said, according to MarketWatch.

In another CNBC interview, Bessent said that the expanded buyback announcement "has nothing to do" with the Federal Reserve and its decision on whether to raise rates later this year.

Evercore ISI senior economist Marco Casiraghi also said the Treasury's expanded buyback program could ultimately weaken the dollar, which could lead to higher inflation.

While all this could be true, it would seem odd, at least in the near term, for the Fed to raise interest rates at the exact time the Treasury is trying to lower long-term yields.

It's likely to make the market wonder who's truly driving the bus and could also result in the market paying less attention to Warsh or taking his claims about reining in inflation less seriously.

Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Evercore. The Motley Fool has a disclosure policy.