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Bond Vigilantes Dare Bessent To Use His Bazooka
On September 1, we warned you that September is back. We wrote, "Everyone in the stock market knows that September is the cruelest month for stocks. But when it is a bad month, it tends to create buying opportunities for a year-end rally that often starts in October." So far, the month has been crueler to bond investors than to stock investors. The 10-year US Treasury yield rose to 4.96% today from 4.76% at the end of August (chart). We think this will turn out to be a buying opportunity if US Treasury Secretary Scott Bessent fires his bazooka to avert a spike above 5.00%. Over the past few weeks, Bessent has displayed several tools to push back against rising Treasury yields, including supporting the yen alongside Japan, expanding long-bond buybacks, and potentially drawing down the Treasury General Account to finance additional bond purchases. Yesterday, the Treasury unveiled a $6 billion buyback operation in the 10- to 20-year sector. However, $6 billion amounts to little more than a rounding error in a $31.8 trillion Treasury market, including $5.5 trillion of long bonds (chart). The Bond Vigilantes are daring Bessent to use the bazooka in his tool kit. That would mean much larger bond buybacks, financed by issuing more Treasury bills. Such an operation has been described as the "Bessent Twist." Meanwhile, traders continue to price in more aggressive Fed tightening, with the 2-year Treasury yield rising to 4.59% today, 100bps above the current effective federal funds rate (chart). That is the largest spread between the two since 2022, during the Fed's post-pandemic rate-hiking cycle. The Fed is increasingly likely to deliver a 25bps rate hike next week. Such a move would reinforce the Fed's inflation-fighting credibility. In our view, it could ease some of the upward pressure on long-term yields. We think the Fed should have made that move back in July. For now, we expect policy actions and strong buying at these levels to keep the 10-year yield within our 4.00%-5.00% range of expectations. Let's review the factors that have contributed to the rise in Treasury yields this week: (1) PPI. The final-demand PPI rose 0.4% m/m in August, the largest increase since May. The jump was driven largely by a 4.2% rise in energy prices (chart). Higher fuel costs also boosted transportation and warehousing prices, which surged 2.3% m/m. The PPI excluding food and energy increased a solid 0.4%, suggesting that underlying producer price pressures remained firm last month. The PPI for personal consumption, a key input into the Fed’s preferred PCED inflation gauge, rose 0.4% m/m in July, the most since May (chart). Excluding food and energy, it rose at a more moderate pace of 0.2%. The core PPI for personal consumption accelerated modestly to 4.6% y/y. It remained above both core PCED and core CPI inflation, suggesting that upside risks to consumer inflation remain elevated (chart). Importantly, PPI components that feed into the PCED, the Fed's preferred inflation measure, came in strong, with airfares surging 4.2% m/m and hospital services prices up 0.5% (chart). That matters because the September 16-17 FOMC decision will likely hinge on what this week's CPI and PPI reports imply for August’s core PCED inflation. Today's PPI report raises the odds of a rate hike, though tomorrow's CPI report remains critical. (2) Oil Prices. Oil prices continued to surge today amid escalating warfare in the Middle East. Brent crude traded near $107 per barrel, while West Texas Intermediate crude climbed to around $101, leaving both benchmarks up roughly 6% for the day (chart). (3) US Economy. While inflation pressures remain elevated, the US economy continues to show remarkable strength. The Weekly Economic Index rose to 3.3% y/y in the week of September 4, its highest reading since August 2022 (chart). The index has increased for three straight weeks now. The Atlanta Fed's GDPNow model currently projects real GDP growth of 4.4% (saar) in Q3, supported by strong consumer spending and robust business investment. The labor market continues to point to an economy operating at full employment. Initial jobless claims remained historically low at 206,000 in the week of September 4, while the four-week average of continuing claims declined for a third straight week (chart). (4) Fiscal Deficit. Bessent and other administration officials have emphasized a strategy focused on fiscal consolidation, debt management, and economic growth to rein in a national debt surpassing $40 trillion. Yesterday, President Donald Trump proposed issuing a $5,000 direct cash dividend to every adult US citizen, contingent on Republicans retaining control of Congress in the midterms. Independent fiscal watchdogs quickly pointed out that a nationwide $5,000 payout would cost upwards of $1.20 trillion to $1.85 trillion. Critics argue that such a massive infusion of cash directly undermines Bessent's deficit-reduction efforts, threatening to reignite inflation and drive up borrowing costs at a time when the federal deficit is already near $2 trillion.
Bessent Tells Bond Vigilantes: "I Am The House"
I. Bessent Intervening On August 19, Treasury Secretary Scott Bessent announced an expansion of the Treasury's buyback program in the long end of the yield curve. Today, the Treasury unveiled a $6 billion buyback operation in the 10- to 20-year sector, with Bessent stating that the goal is to ensure "that there is not a bad, big adverse outcome" in the Treasury market. However, the market remained unconvinced, with the 10-year Treasury yield rising to 4.85%, its highest level since November 2023. Investors remain focused on the fundamentals supporting elevated long-term rates, including robust consumer spending, an AI-led capital spending boom, huge federal deficits, and inflation stuck above the Fed's target. Nevertheless, we continue to expect the 10-year yield to remain in the back-to-normal 4.00%-5.00% range (chart). If so, Bessent may be overreacting because he fears more than we do that the Bond Vigilantes will drive yields above 5.00%. Bessent is talking loudly and carrying a big stick. The "Bessent Put" raises the odds that 5.00% won't be breached, making bonds at these levels more attractive. On July 31, Bessent also joined Japan in supporting the yen after the currency plunged to a 40-year low against the dollar. Japan still spent a record $98.6 billion defending the currency between July 30 and August 26, partly financed through Treasury sales. The yen has since rebounded more than 6% from its late-July low (chart). In our view, the interventions helped establish a floor under the currency, while the subsequent rally reflected a hawkish repricing of BOJ policy and an unwind of short-yen carry trades. A big stick often works. The broader takeaway is that Bessent is willing to intervene when he believes markets have drifted too far from fundamentals. He has framed this strategy as leveraging "asymmetric information" to force speculators to reassess their views. Yesterday, in a speech at Southern Methodist University, he declared: "I am the house now." Referring to coordination with Japan, he added, "When we intervene with the Japanese yen, I have pretty good insight into what the Bank of Japan is going to do ... Bet against me if you want." Meanwhile, the latest economic data show that despite the recent rise in bond yields and the rebound in oil prices, the labor market is improving and consumers show no sign of retrenching. II. Consumers Consuming The latest labor market data suggest the US economy continues to operate at full employment. According to ADP, private employers added an average of 12,500 jobs per week in the four weeks ending August 22, equivalent to a monthly pace of 50,000 jobs (chart). We think that is sufficient to keep the unemployment rate around 4.0%. The latest NFIB survey shows that 17% of small businesses planned to increase employment in August, above the historical average of 11% (chart). Job openings remained 11 points above their historical average. Hiring likely remains constrained by a shortage of skilled workers, with 47% of firms reporting no qualified applicants for an open position, well above the historical average of 37%. Another upbeat sign for overall payroll employment is that the y/y growth rate of temporary help employment turned slightly positive during August for the first time since October 2022 (chart). Despite elevated energy prices, consumers continue to spend at a solid pace. Redbook same-store retail sales rose by 8.3% y/y during the week of September 04, well above the 2025 average of 5.8% (chart). III. Inflation Inflating While the labor market data suggest the Fed has no reason to worry about the full-employment side of its dual mandate, the inflation picture remains unsettling. Oil prices surged above $100 per barrel today for the first time since July as the US-Iran conflict re-escalates. Higher oil prices will boost headline inflation and increase the risk that temporary supply shocks become more persistent inflationary pressures, strengthening the case for the Fed to raise the federal funds rate next week. Diesel prices have also continued to surge, reflecting tightening global distillate supplies and refinery disruptions (chart). Because diesel fuels much of the transportation, agricultural, and industrial sectors, higher diesel costs tend to raise prices across the broader economy. Grain prices are also spiking amid Black Sea export disruptions, extreme weather-related crop losses, and rising energy and transportation costs (chart). This is likely to filter through to consumer food prices with a lag. On a more encouraging note, the latest NFIB survey shows that the percentage of firms planning to raise prices was 28% in August, the lowest since April (chart). However, the overall data suggest inflation remains a troublesome issue for the Fed.
ECONOMIC WEEK AHEAD: September 7-11
August payroll employment jumped 162,000, a sharp reversal from July's decline, while the August unemployment rate held steady at 4.1%. Those numbers reinforce our view that the labor market remains solid, so the Fed has little reason to delay a rate hike. The federal funds futures market now prices a 59% chance of a hike at the September 15-16 FOMC meeting, up from roughly 50/50 before the employment report, with room to move either way once fresh data lands. This week, attention turns to inflation, with August's PPI (Thu) and CPI (Fri) coming out. Overseas, China's CPI and PPI (Wed) and the European Central Bank's (ECB) meeting (Thu) top the international agenda. We will also see earnings reports from Oracle and Adobe (Thu). Here's more: (1) Inflation. The Cleveland Fed Inflation Nowcasting model projects August CPI (Fri) rose 0.36% m/m and 3.38% y/y, unchanged from July's 3.4% (chart). The model's core CPI projection eases to 0.20% m/m and 2.38% y/y, down from 2.5% in July. A mild print this week could pull the odds of a September Fed rate hike back down. An upside surprise would practically guarantee a majority vote to hike at the FOMC's September 15-16 meeting. Rising high-tech component costs continue working through the pipeline. PPI Electronic Components & Accessories is up 28.0% y/y, outpacing CPI Computer Software & Accessories, up 21.2% (chart). The gap suggests plenty of upstream pressure still has room to work through to the consumer level. Record diesel fuel prices are also putting upward pressure on inflation. Headline PPI Final Demand cooled to 4.7% y/y in July from 5.5% in June (chart). The underlying trend remains sticky, though. The measure excluding trade services was 5.2%, and the core PPI came in at 4.7%. (2) Unemployment Claims. Initial claims was 206,000 for the week ending August 28, with the four-week average at 207,300 (chart). That's consistent with Friday's employment report, which showed the unemployment rate holding at 4.1% in August alongside broad-based job growth, with no signs of rising layoffs. (3) Global. The ECB meets Thursday, with markets treating a hike to 2.50% from 2.25% as a virtual certainty (chart). More interesting will be what ECB President Christine Lagarde signals for October’s meeting; the odds of a follow-up hike then sit at just 31.5%. China's PPI climbed to 3.5% y/y in July, its firmest reading in years, driven by mining and raw materials prices (up 16.4% and 6.1% y/y, respectively) amid global commodity price pressures (chart). The CPI has barely moved, at 0.5%, so the reflation so far looks like a factory-gate story rather than a consumer one. August's data (Wed) are expected to show a small pickup in both measures.
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