New chapters of hubris in central financial planning are written on a regular basis. But rarely is one inscribed with such spectacular timing.
Treasury Secretary Scott Bessent recently stood before an audience at Southern Methodist University and dared currency traders to bet against his currency interventions. While doing so, he delivered a line for the history books.
Bragging about his access to policymakers in Tokyo and his inside track on foreign central bank maneuvers, Bessent declared, “I am the house now. You can bet against me if you want.”
Bessent believes that with enough bluffing, strategic bond buybacks, and coordinated intervention with the Bank of Japan, he can dictate terms to the financial markets. The global debt market, however, does not buy it.
While Bessent was playing risky currency games, the yield on the 10-Year U.S. Treasury note eclipsed 5 percent. Investors across the globe delivered a direct, explicit response to Washington’s market intervention. Bessent can claim to be the house all day long, but when the U.S. government’s running $2 trillion annual deficits while inflation is running hot, the bond market will inevitably price in the risk.
The immediate catalyst for this surge in yields is an economic landscape characterized by disruption and disorder. This week, West Texas Intermediate crude oil ripped past $104 a barrel, and Brent Crude breached $108 a barrel. Energy supply disruptions and geopolitical uncertainty continue to escalate. The latest being the drone destruction of Saudi Arabia’s East-West crude oil pipeline. But not to worry. Energy Secretary Chris Wright says the pipeline will be fixed in a matter of days.
Regardless, energy spikes are the ultimate indicator for consumer price inflation expectations. And the timing couldn’t be worse.
Debt Trap
Last Friday, the Bureau of Labor Statistics released the August Consumer Price Index (CPI) report. It showed consumer price inflation has increased 3.4 percent over the past year.
While a 3.4 percent CPI reading might sound manageable compared to recent historic spikes, like the 9.1 percent reached in June 2022, it marks another month where inflation remains stubbornly above the Federal Reserve’s official 2 percent target.
A look back at America’s last serious bout with runaway consumer price inflation in the late 1970s and early 1980s presents a painful prospect. Back then, between puffs of a cheap cigar, Fed Chair Paul Volcker was forced to wreck the American economy to save the veracity of its money.
Volcker broke the back of inflation by aggressively hiking interest rates. By the time he was done, the 10-Year Treasury note yield hit a lofty peak of 15.31 percent in September 1981. It was a brutal remedy that triggered a deep recession. But it succeeded because it convinced global markets that the Fed was willing to take necessary measures to restore credibility to the dollar.
Today, however, the Volcker playbook cannot simply be repeated. The reason is Washington’s massive pile of debt.
In 1981, the U.S. national debt was a tiny fraction of total economic output, hovering around 30 percent of Gross Domestic Product (GDP). Today, the national debt exceeds 120 percent of GDP.
In 1981, the federal government could survive double-digit interest rates because the overall debt burden was small. Today, the U.S. government is simply too broke to afford interest rates over 15 percent. In truth, the Treasury can barely afford interest rates remaining above 5 percent for any extended duration.
Walking the Walk
When the yield on the 10-Year Treasury note sits above 5 percent, the mathematical feedback loop gets ugly very quickly. Net interest payments on the national debt rapidly eclipse major spending line items like defense and healthcare.
Refinancing trillions of dollars in maturing short-term debt at 5 percent forces the Treasury to issue even more debt just to pay the interest on the existing obligations. That massive wave of new supply depresses bond prices further, driving yields even higher. No amount of bluster from Treasury Secretary Bessent can alter the underlying arithmetic of this fiscal doom loop.
Which brings us to Fed Chair Kevin Warsh and this week’s Federal Open Market Committee (FOMC) meeting held on September 15 and 16. Warsh assumed the chairmanship promising an operational regime change. He’s advocated a philosophy grounded in price stability and reduced reliance on extensive forward guidance.
Throughout his brief time on the job, he has sounded overtly hawkish on inflation. He’s signaled to markets that he would not stand idly by while price increases run above target. Warsh has publicly warned that anyone expecting the central bank to remain accepting of persistent inflation would be sorely disappointed.
This week it was time for him to make good on his promises. Was he just talking the talk? Or would he also walk the walk?
Warsh went into the FOMC meeting facing challenging conditions. Oil over $100 a barrel. A CPI running at a hot 3.4 percent. And long-term Treasury yields breaking out. At the same time, President Trump has made no secret of its desire for lower interest rates to keep economic growth humming and ease the Treasury’s borrowing costs.
Warsh Defies Trump
By Wednesday afternoon the FOMC meeting had concluded. The Fed officially hiked the federal funds rate up by 25 basis points, bringing the target range to 3.75 to 4.00 percent.
By delivering a rate hike, Warsh advocated for the Fed’s institutional independence. He also reinforced some credibility on inflation. The short-term cost is the worsening of the Treasury’s immediate debt service pain. He also triggered the wrath of President Trump, who took to Truth Social to voice his frustrations:
“Interest Rates in the United States should be 1%, or less, because we are the Best Credit in the World — BY FAR. Our Country is BOOMING with new Investment! If we stopped Trading with every country that we have a Deficit with, which is most of them, we would make, at least, 1.5 Trillion Dollars a year. The word “Deficit” is nothing more than a fancy word for LOSS. We are “carrying” almost every country in the World, and that cannot go on any longer. LOWER THE INTEREST RATES FOR THE UNITED STATES OF AMERICA, AND FAST! President DONALD J. TRUMP”
When it comes down to it Warsh had no choice but to raise rates. If he’d held rates steady, he would have telegraphed to capital markets that the Fed has submitted to political pressure. This potentially could have sent inflation expectations and long-term bond yields even higher.
Of course, rate hiking cycles are rarely one and done. Despite what Trump says, there will likely be another rate hike – perhaps two – before the year is over.
This brings us back to Bessent, and his childish hubris. When a Treasury Secretary boasts that “I am the house,” he’s flouting a fundamental rule of global capital. In sovereign debt markets, the bond market is the house. Investors always retain the power to demand higher yields until the risk is properly priced.
Bessent knows this. But he’s politically compromised.
Restoring ultimate faith in the dollar requires more than short-term market intervention gimmicks or verbal bluffing. It requires a hard return to fiscal sanity and monetary discipline.
Until Congress and the President address Washington’s insane debt level and balances the budget, a 5 percent yield on the 10-Year Treasury note may not be a temporary ceiling, but rather an inflection point on the curve to double digit interest rates.
In other words, it’ll be game over for the dollar in its current form.
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Sincerely,
MN Gordon
for Economic Prism
