Trump Administration Cornered by Soaring Treasury Yields Right Before Midterms

Starting last Monday, interest rates in the U.S. Treasury market surged, escalating issues in both politics and economics. Treasury Secretary Yellen intervened with an emergency bond buyback to stabilize the market.

The Treasury doubled the buyback amount from $2 billion to $4 billion, but its effect disappeared within a day. Compared to the size of the Treasury market, this is considered 'a drop in the ocean.' Market participants believe this scale cannot fundamentally halt the rise in interest rates.

More critically, the Treasury Department's policy signals have lost consistency. Two weeks prior, when announcing the quarterly bond issuance plan, the Treasury publicly declared that its bond issuance plan remained unchanged to stabilize the bond market. However, just two weeks later, it suddenly altered the bond issuance plan and announced an expanded buyback. This caused confusion and mistrust in the market. The fact that 10-year yields at 4.7% and 30-year yields at 5.3% are explicitly recognized by the government as a 'pain point,' and that annual buybacks of tens of billions of dollars can only have short-term, temporary effects, increased market concerns.

Treasury Secretary Bessent, in a 2025 podcast, referenced the 1992 battle against speculation on the British pound. At the time, he, along with the Soros Fund, attacked the pound, explaining the British government's situation as an 'asymmetric information' problem. The UK had pegged the pound to the German mark, but defending it required raising interest rates, which would worsen the British economy (especially as most UK mortgages were variable-rate). The government was in an unbalanced situation, having to choose between defending the pound and worsening the economy, a weakness Soros exploited.

Some analyses suggest it's premature to deem Treasury Secretary Bessent's intervention a failure at this stage. This is because the designated 'pain points' of 4.75% for 10-year yields and 5.4% for 30-year yields have not yet been breached. While interest rates continue to rise, the key is whether they can be sustained at this level. It's also noteworthy that Secretary Bessent has several additional policy tools at his disposal.

The issue of policy consistency is also emerging. Fed Chair Powell abolished forward guidance (indicating future interest rate direction), signaling to the market, 'Don't look at our mouths, but judge by the indicators.' The intention was for the market to determine prices independently. However, if the Treasury intervenes directly with buybacks, the market will inevitably focus only on the Treasury's movements, not the Fed's words. Furthermore, the lack of clarity regarding the size, frequency, and duration of the buybacks is increasing market uncertainty.

Secretary Bessent's change in demeanor is also noteworthy. Usually relaxed and often smiling, he appeared very anxious in a recent CNBC interview. He was so proactive that he even gave individual interviews to other reporters after his exclusive with CNBC. The content of his interviews amounted to warnings like, 'I have information you don't,' and essentially telling the market, 'Don't mess around, don't short-sell.'

This shift in attitude suggests a significant decrease in Secretary Bessent's conviction. In the 1992 British pound battle, he had deep confidence in his strategy. Now, however, he is perceived as being cornered and stressed. This change in demeanor is interpreted as a signal of weakening confidence in the current policy.

The political intent of the policy is also clear. The Treasury set the expanded bond buyback period until November 4th, with November 3rd being the exact date of the midterm elections. The Trump administration appears to be aiming to stabilize interest rates right before the vote. This is not merely an economic policy for rate stability but part of a political strategy targeting a midterm election victory. Measures to remove beef tariffs and expand imports are also being taken in the same vein.

What the market anticipates is the Treasury's fiscal consolidation plan. Secretary Bessent has announced that a fiscal consolidation plan will be released next week or the week after. Until then, interest rates are likely to remain at current levels. However, there is concern that if the announced plan does not satisfy the market, interest rates could sharply rise.

The Federal Reserve has tried to emphasize the separation of fiscal and monetary policy. Yesterday, too, FED officials tried to draw a line that the two policies are separate. However, in reality, the Treasury's bond buyback has the same effect as monetary policy, effectively erasing the practical boundary between the two policies. Moreover, the problem is exacerbated as the FED's oversight does not function when the Treasury intervenes.

There are also structural reasons why a fiscal consolidation plan is difficult to produce. Social Security and Medicare-related items account for more than half of the U.S. federal budget. Without touching these areas, real fiscal consolidation is impossible. However, these two items are politically the most difficult to address. Consequently, a long-term vision is unlikely to emerge.

The speed of interest rate increases is also a metric to watch. According to Goldman Sachs analysis, while the absolute level of long-term bond yields is an issue, if rates rise too quickly, problems can arise in the stock market. If interest rates surge before companies have time to adapt, market accidents occur. The past standard was exceeding one standard deviation within a month, which for 10-year bonds is typically about 30 basis points (bp) of increase in a month. This time, it only rose about 15bp, falling short of the standard. However, the absolute level of 10-year bond yields is high compared to levels before the 2007 financial crisis.

Interest rates exceeding the growth rate is a normal phenomenon. This signals that companies can tolerate the current interest rate levels. If economic growth falters, interest rates will naturally decline.

Another factor contributing to the rise in Treasury bond yields is the surge in AI corporate bonds. As Treasury yields rise, an increase in corporate bond issuance creates a vicious cycle where both push each other's yields higher. Large, capital-rich corporations like NVIDIA have no problem raising funds in this environment, but nascent AI companies could be hit. There's concern that companies with weaker capital-raising capabilities may not withstand increased borrowing costs due to high interest rates.

The Federal Reserve's Federal Open Market Committee (FOMC) is also concerned about large-scale borrowing by AI companies. FOMC members have identified AI companies' borrowing as a factor in financial instability and inflation. They also anticipate an increase in stock market risks due to rising interest rates.

Comparing interest rate levels with other developed countries, the U.S. situation is relatively better. For 10-year bonds, the U.S. raised rates by about 50bp, while Japan raised by over 80bp and the UK by 60bp. Even if the U.S. is experiencing an interest rate crisis, Japan and the UK's economies remain robust despite larger rate hikes.

China also has ways to pressure the U.S. in the short term. Currently, oil prices are maintained at their present level because China has reduced oil imports. If China decides to buy large quantities of oil, prices could surge above $100. High oil prices would cause political pain for the Trump administration. From China's perspective, controlling oil prices allows it to inflict short-term damage on the U.S. economy and gain negotiation leverage.