Scott Bessent Is Fighting the Wrong Battle
The US Treasury secretary is trying to suppress long-term yields instead of addressing deficits and inflation, complicating the Federal Reserve’s task and creating further risks for Europe. A commentary by Ignazio Angeloni
As time passes, US Treasury Secretary Scott Bessent increasingly risks becoming a danger to the global economy. It was not always so.
In the closing weeks of 2024, when President-elect Donald Trump was selecting members of his administration with careful attention to their loyalty to the leader and their telegenic appeal, the appointment of Bessent reassured almost everyone. Here, at least, was someone with a proven record in finance.
Stanley Druckenmiller, the legendary hedge fund manager, put it this way: “He worked with me and George [Soros]. He learned everything he needs to know.”
That could hardly be further from what Druckenmiller wrote in The Wall Street Journal last Monday, accusing Bessent of getting everything wrong in his management of the world’s most important financial market, the market for US Treasury securities.
How did poor Bessent go, in such a short time, from being the only “adult in the room” in an improvised administration to becoming a loose cannon in the international financial system?
Let us take things in order.
Over the past five years, since the world emerged from the pandemic, interest rates have begun to rise again, just as prominent economists were publishing books explaining their secular decline.
After returning to the levels seen before the global financial crisis, long-term rates in the US, and in their wake elsewhere in the world, continued to increase (Chart 1).
The rise has not been chaotic. It has been gradual and orderly, suggesting that global financial markets, in which US Treasury securities are traded, have a clear sense of both the direction of travel and the reasons behind it.
There are three main reasons.
The first is the race to develop artificial intelligence. It promises returns over the long term but, for now, requires colossal investment, amounting to as much as 2 per cent of US GDP this year, according to Goldman Sachs estimates.
The second, and most important, is the unprecedented US fiscal deficit, projected at 6 per cent of GDP in 2026, alongside public debt that has exceeded 120 per cent of GDP. Rising debt and rising interest rates are an explosive combination for the public finances, even in a country that prints dollars.
Interest expenditure this year, at 3 per cent of GDP, exceeds the defence budget. All this is happening while the US economy is at full employment and inflation is running at between 3.5 and 4 per cent, compared with the Federal Reserve’s 2 per cent target.
Given these conditions, the rise in long-term rates is both natural and unavoidable. The associated risks must be addressed by tackling the causes rather than the symptoms, above all the fiscal deficit and inflationary pressures.
This is precisely the opposite of what Bessent is doing.
Disappointing those who expected him to exert influence over fiscal policy, the Treasury secretary first intervened in support of the Japanese yen, ostensibly to assist an ally but, more realistically, to prevent Japan, the largest foreign holder of US government debt, from selling Treasury securities.
He then began supporting the Treasury market directly through large-scale buybacks. These operations alter the maturity structure of the debt by retiring long-term securities and increasing the share of short-term issuance.
It is hardly surprising that the effects proved short-lived. Indeed, the strategy risks being counterproductive by exposing the absence of adequate policy responses and the underlying weakness of the Treasury secretary himself.
The risks are considerable, both within the US and beyond its borders.
In its logic, although not in its scale, the buyback programme resembles the so-called Operation Twist pursued by the US in the 1960s to reduce long-term interest rates.
That operation also failed. It aggravated the imbalances it was intended to conceal and helped prepare the ground for the sharp depreciation of the dollar and the inflation, including global inflation, that followed a few years later.
There is a further aggravating factor. On that occasion, the operation was conducted by the central bank. Today it is the Treasury that is intervening, while generating monetary consequences that run counter to what the Federal Reserve, now led by Kevin Warsh, should do and is probably preparing to do.
With inflation running at almost twice its target, the Fed will have to raise interest rates unless the outlook changes dramatically. If it does not act sooner, it will probably do so after the November midterm elections.
By shortening the financial duration of the public debt, the Treasury’s policy is indirectly equivalent to quantitative monetary easing. It therefore runs against the direction of Federal Reserve policy.
This is another problem for Warsh, who may now be wondering whether to address the issue or avoid it in his speech at the Jackson Hole conference today.
The consequences also matter for Europe. The spillover from higher US interest rates is reaching this side of the Atlantic, compounded by the political, economic and financial weakness of Germany and France (Chart 2).
Europe lacks the expansionary impetus provided by technology investment in the US. But, albeit to varying degrees, it shares America’s fiscal weakness.
Through a prudent fiscal stance, the Italian government has managed in recent years to contain the yields on its long-term debt. The spread has narrowed.
However, the spread ceases to provide an unambiguous signal once yields on the debt of other European countries become less stable.
The absolute level of interest rates becomes more important.
Recently, yields have begun to rise again in Italy, tightening the constraints on debt sustainability.
Weak US financial leadership is one factor, although not the only one, making the outlook more difficult. For Italy, it argues for the greatest possible caution on fiscal policy, particularly as the country approaches the coming electoral cycle.
A previous version of this article was published in the Italian daily Milano Finanza
IEP Bocconi does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
