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On Learning From Japan & Investing In Brazil
The US Treasury’s attempt to free the bond market from the Bond Vigilantes by injecting more liquidity via buybacks recalls Japan’s similar decision prior to its “lost decades.” The US economy isn’t headed for any such abyss, but Japan’s experience nonetheless highlights the tactic’s drawbacks. Liquidity can soothe a market, William writes, but not cure what’s ailing it in the first place. … Brazil’s central bank is in a tough spot: Its push to curb inflation has taken an economic toll right before a presidential election. … And: Toby points out an opportunity in Brazilian stocks. Valuations have dropped as share price gains haven’t kept pace with rising earnings expectations.
The Latest Pitch of America's Top Bond Salesman
I. The New Treasury-Fed Accord In November 2025, Treasury Secretary Scott Bessent said, "My job is to be the nation's top bond salesman. And Treasury yields are a strong barometer for measuring success in this endeavor." Recently, however, the Bond Vigilantes are demanding lower prices (higher yields) for what Bessent is selling. The 10-year Treasury yield reached its highest level of the year, while the 30-year climbed to its highest level since 2007 (chart). That has prompted Bessent to make three sales pitches to the Bond Vigilantes recently: Pitch I came when the Treasury joined Japan in a rare intervention to support the yen after it fell to multi-decade lows, reducing the risk that Tokyo would have to sell its US Treasury securities to prop up its currency. That support actually unnerved bond investors by reminding them that the US depends heavily on the kindness of strangers. Pitch II came last Wednesday, when the Treasury doubled buybacks of 10- to 30-year securities to $4 billion per operation. During Janet Yellen's term as US Treasury Secretary, the buyback program was designed to support secondary market liquidity by regularly buying back less liquid, "off-the-run" nominal coupons and TIPS. Pitch III came today, when CNBC reported that the Treasury could use its nearly $1 trillion Treasury General Account (TGA) to help fund expanded long-bond purchases. TGA is the Treasury's checking account at the Fed. This may be the start of the Treasury's own version of Operation Twist. In the original Operation Twist, the Fed sought to lower long-term interest rates by selling short-term Treasuries and buying long-term ones. The strategy was first used in 1961 with modest success and revived in 2011, when it is estimated to have lowered 10-year Treasury yields by 15-25 basis points. In Bessent's latest version, the Treasury would use TGA cash to buy long-term securities, putting downward pressure on long-end yields. The catch is that the TGA will have to be replenished through additional Treasury bill issuance. Once those bills are issued, the hot potato falls back into the Fed's hands. The additional supply of bills would force the Fed to buy some to offset upward pressure on the federal funds rate, which is currently pegged at a range of 3.50%-3.75%. By the way, the Treasury's efforts to keep a lid on the long end thus spill back into monetary policy. They also make it harder to obtain a clean read on what bond markets are saying about the appropriate stance of monetary policy. That undermines Fed Chair Kevin Warsh's goal of relying more on market signals. Our view is that much of this might have been avoided if the Fed had conducted its own version of Operation Twist at the July FOMC meeting by raising the federal funds rate 25 basis points. That would have boosted the Fed's inflation-fighting credibility, lowering inflation risk premiums and long-term yields. In other words, Warsh could have achieved the same result without causing Bessent to resort to sales gimmicks. Let's have a closer look at "T-Fed," i.e., a consolidated view on how the Treasury and the Fed interact. (1) Meet T-Fed. The Treasury continues to maintain nearly $1 trillion in the TGA as prudent cash management to pay the federal government's bills (chart). Consequently, any significant TGA drawdown to buy back Treasury bonds would need additional Treasury issuance in the bill market to replenish the Treasury's checking account. Federal outlays significantly exceed receipts, meaning the Treasury routinely spends more cash than it takes in (chart). It must close the gap through borrowing so the TGA is large enough to make payments smoothly. The Treasury must also assume that Congress will regularly fail to raise the debt limit for political theater. Running the TGA down to near zero, followed by a government shutdown, is what always causes Congress to raise the debt limit. Yes, we know, it's pathetic! Treasury's growing financing needs are evident in the steady rise of marketable debt held by the public, with Treasury increasingly relying on bill issuance in recent years to fund persistent budget deficits (charts). Meanwhile, the Fed has been buying Treasury bills at a faster pace since the start of this year (chart). Pegging the federal funds rate at 3.50%-3.75% has required the Fed to buy bills to reduce upward pressure on short-term rates from the increased supply. (2) The Fed's balance sheet. Although QT2 has reduced the Fed's securities holdings from their peak, the balance sheet remains enormous (chart). Under QE5, which started December 12, 2025, the Fed has conducted reserve management purchases (RMPs) of Treasury bills only. The initial purchase was $40 billion. The Fed's securities portfolio remains dominated by Treasuries, while MBS holdings continue to run off gradually, increasing the Treasury share of the balance sheet (chart). II. Global Economy August's S&P Global PMI data underscore the global economy's resilience, helping explain why bond yields remain elevated worldwide. The Eurozone's latest indicators may be recovering from very depressed levels. Here's more: (1) Global Flash PMIs. In the US, the flash S&P Global NM-PMI jumped to 56.8 in August, a 20-month high (chart). The M-PMI eased but remained consistent with robust manufacturing activity. For the Eurozone, manufacturing activity rose to a 51-month high, while the NM-PMI held at its highest level since February (chart). The Japanese M-PMI and NM-PMI both remain firmly in expansionary territory (chart). (2) Eurozone's Economic Sentiment Indicator. Economic Sentiment in the Eurozone improved slightly in July but remains below the long-term historical average of 100 (chart). Industrial production has been improving across several of the Eurozone’s largest economies since early last year, though activity levels remain historically subdued (chart). Overall Eurozone consumer confidence improved slightly in August but remained deeply negative (chart).
Trump Threatens Military Action Against The Bond Vigilantes
The Bond Vigilantes have driven up Treasury bond yields recently, thundering onto the scene in alarm over the government’s huge borrowing needs, record corporate bond issuance, three inflationary supply shocks, a cloudy Fed path, resilient nominal GDP growth, a higher neutral interest rate, and a fragile yen. On the flip side, the Trump administration is determined to keep yields tethered—one way or another. Also holding yields in check are slightly cooler economic momentum, moderating labor costs, and the prospect of less policy uncertainty. Ed and Elias expect those counterweights to keep the 10-year yield mostly within our 4.00%-5.00% expectation range, the “old normal.” … Also: Ed reviews “Tuner” (+ + +).
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