The Retired Investor: U.S bond prices fall as oil prices and inflation expectations rise

This month, the U.S. Treasury plans to triple its U.S. bond purchases from $2 billion to $6 billion from Sept. 4 through Nov. 4. Given that the market value of the Treasury market is about $30 trillion, that is a drop in the bucket if the intent is to cap yields on the long end of the yield curve.

Could the Treasury do more? Yes, according to some estimates, they could spend almost $1 trillion if they wanted to use up their checking account (called the general account). That is a lot of firepower, especially on the margin when one is seeking to control the ascent of bond yields. Debt analysts argue that the actual yield of a bond matters less than how quickly the yield accelerates.

As of this writing, the U.S. Ten-year benchmark bond is yielding 4.91 percent, while the thirty-year is yielding 5.34 percent. The present back-up in yields is not only a U.S. problem. Mounting debt and aging populations hit by a trio of global shocks- higher oil prices, inflation, and government spending are coming home to roost.

U.S. Treasury Secretary Scott Bessent would deny that. He believes U.S. interest rates are going higher because investors believe economic growth is reaccelerating. That could be true, but it could also be a wishful spin given that we are just a few weeks away from midterm elections. In any case, don’t be surprised if the Treasury ups the amount of purchases they make again in the days ahead.

At the same time, Kevin Warsh said in his Jackson Hole speech that the Fed needs to do more work to get inflation down to its 2 percent target. The current Wall Street narrative is that Bessent is trying to cap long-term bond rates while Warsh is preparing to do the opposite — hike rates. On the surface, it appears that the two men are working at cross purposes. But could there be another explanation?

Consider this: what happened when Jerome Powell cut interest rates in September 2024 and then again in 2025? Long-term Treasury yields went up, not down, breaking a historical, four-decade cycle. Long bonds have almost always tracked the Fed's path lower. Why the change? Because the bond vigilantes began pricing in stronger-than-expected economic growth and persistent inflation.

I suspect that if Warsh had delivered a dovish message, those same vigilantes would have jacked yields higher than they already are! No, both men are working together, in other ways, for a good reason. Back in June, in a column on sovereign debt, I wrote this:

"Former Treasury Secretary Henry Paulson, who navigated us through the Great Financial Crisis of 2008, warned of a potential "doom loop" in the bond market. He worries that demand for U.S. government debt could collapse soon.

I warned readers that this could trigger a cycle of lower bond prices, higher yields, and rising inflation. The fact is that our government's Treasury market underpins everything from mortgage rates to corporate borrowing to equity prices. The former head of the Treasury urged policymakers "to prepare an emergency plan and have it ready if and when demand for U.S. government debt falters."

A crisis, as Paulson suggested, would leave the Federal Reserve as the lone buyer of our treasuries. Realistically, that would mean the government would be forced to "print" money in one form or another. That would trigger a fresh round of inflation, eroding valuations across most asset classes, including equity. This could cause a large (30 percent+) decline in the stock market."

That was a strong warning, and I believe both the Treasury and the Fed have taken him seriously. We are witnessing the beginning of such a plan. It is to be rolled out in stages. The Fed's credibility had to come first. The appointment of Warsh as the new chairman of the Federal Reserve Bank has triggered worries that the Fed's independence is in jeopardy.

The president, an easy money advocate, had attempted to "pack" the 12-member Fed committee with his people. He also made clear that Jerome Powell's replacement would need to tow his line. As a result, Kevin Warsh came into the job tainted with a heavy dose of suspicion from skeptics both here and abroad.

Warsh's hawkish statements thus far have largely dispelled many of those fears. His willingness to let the markets dictate where long bond rates should go, while providing less communication to the financial markets, may also be part of this plan. His study committees, which analyze and adjust government data used to determine monetary policy decisions, are also part of the plan.

We will know more about how the Fed views the economy and inflation next week. The betting markets indicate that there is now a 70 percent chance than the Fed raises interest rates at their FOMC meeting on September 15-16.

Next week, I will address how the two organizations might work together, especially in a period where the possibility of Hank Paulson's 'doom loop' appears closer than ever.