US Treasury Market Faces Uncertain Path After Wild Week of Bond Yield Swings

The US Treasury market is in a volatile week, and investors are once more left with uncertainty about what bond yields will be and what the Federal Reserve will do if borrowing costs rise again.

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Treasury securities came under renewed pressure on Friday as economic data showed US business activity expanding at its fastest rate in more than four years. That solid reading and high interest rates also bolster the likelihood the Fed will keep interest rates higher for a long time, putting short-term Treasury yields in demand.

The two-year Treasury yield rose nearly five basis points to around 4.23 percent, and the benchmark 10-year yield rose about three basis points to 4.73 percent.

The developments capped a turbulent week in the U.S. bond market, which was rocked by the Treasury Department's announcement that it plans to expand its debt buyback programme. It has been portrayed as a way to boost liquidity in older Treasury securities, but the market has also seen it as an effort to ease pressure on borrowing costs and the bond market.

The announcement on Wednesday sent long-dated Treasury yields down on the following day. But yields had come back the next day: Investors were wondering how effective the Treasury's strategy would be.

What Treasury Secretary Scott Bessent would do if bond yields resumed rising is a central question.

Bessent spoke about the policy of Treasury buybacks on Thursday and said officials might consider additional measures to address US borrowing costs. But he declined to comment, and investors do not know the government’s broader strategy.

One problem is that Treasury intervention itself comes at a cost. Analysts say the government can currently finance buybacks by shifting its borrowing to shorter-term debt. But given that the overall U.S. federal debt is constrained by the debt ceiling, the Treasury’s ability to use that strategy is not unlimited.

And Philip Marey, senior US strategist at Rabobank, said that the Treasury could eventually run out of room to help the market if borrowing costs rise dramatically again.

Would the Federal Reserve have to intervene in the future?

If Treasury measures do not stop a new surge in long-term yields, the central bank would face pressure to purchase government bonds. That would be an abrupt change in the Fed’s balance sheet strategy and would make it harder to wind down its holdings of Treasuries.

The debate comes at a sensitive time for Fed policy. Kevin Warsh, who will be central to discussions around monetary policy and the balance sheet at next week’s Jackson Hole Economic Policy Symposium in Kansas City, will be there.

Another possible policy response might be to change the maturity profile of Treasury issuance.

Some changes in the language in the Treasury’s quarterly debt-issuance statement have led to speculation officials could reduce the supply of very long-term bonds and instead rely more heavily on short and medium-term maturities.

Such a strategy could put pressure on long-dated yields, but it would also increase the government’s reliance on shorter-term borrowing.

Western Asset Management portfolio manager Robert Abad said the Treasury’s reaction to another potential rise in yields would be an important indication of whether policymakers are primarily concerned about market functioning or are also becoming concerned about the absolute level of borrowing costs.

So investors will look for more buybacks or changes in the level of long-term debt issuance.

But some fixed-income investors argue that Treasury intervention alone cannot fundamentally reverse the direction of bond yields.

Gregoire Pesques, chief investment officer for global fixed income at Amundi, said buybacks could send a powerful signal but may not be enough to drive yields sustainably lower. He also suggested that the Federal Reserve might need to raise interest rates to emphasize its commitment to controlling inflation.

That argument is also echoed by Goldman Sachs strategists who have maintained that a sustained decline in inflation would be a better path to lower Treasury yields than government intervention in the bond market.

The latest economic data have complicated the picture even more. Strong business activity could indicate that the US economy still has a lot of momentum and thus reduces the urgency for monetary easing, with interest rates likely to stay high.

The market is already pricing in a lot of uncertainty about the next move from the Federal Reserve. Interest-rate swaps are pricing in roughly a 40% probability of a rate hike at the September meeting, and a rate hike is only fully priced in toward the end of the year.

As investors get ready for next week’s Jackson Hole meeting, attention will be on fiscal and monetary policy. The Treasury’s appetite for buybacks, whether long-term debt issuance will be curtailed, and the Federal Reserve’s response to inflation and yields will all shape the next phase of the US bond market.

For now, the Treasury's intervention has raised more questions than answers. Investors remain unconvinced that government debt-management measures will be enough to address the deeper challenges facing the world's largest sovereign bond market.