Bessant wants to save US debt, while Warsh wants to fight inflation. Will the Treasury and the Federal Reserve "go their separate ways"?

U.S. Treasury Secretary Bessant's sudden intervention to expand long-term bond repurchase agreements is directly clashing with Federal Reserve Chairman Warsh's anti-inflation stance. Major Wall Street investment firms are widely warning that the policy objectives of the two institutions have diverged significantly, and this tension will likely erupt during Warsh's Jackson Hole speech this Friday.

Last week, Bessant announced it would "at least double" the size of its long-term Treasury repurchase program in an attempt to curb rising long-term yields. However, the intervention's effect faded in less than a day, and yields subsequently returned to high levels. Meanwhile, the dollar fell nearly 1% that week, gold broke through $4,600, and Bitcoin rose more than 25% in a single week—a combination the market interpreted as a fervent embrace of the "currency devaluation" narrative rather than a signal that the policy was working.

Warsh will speak in Jackson Hole, Wyoming this Friday. This will be his first major public address since the controversy surrounding the July interest rate decision, and the first time he has faced such intense market pressure since taking office in May. Traders are most eager to know: what exactly is the Fed's policy response function in the face of persistently high inflation above the 2% target and a deteriorating fiscal situation?

Bessant's intervention in the bond market had limited effectiveness and was highly controversial.

Bessant's actions come against the backdrop of long-term U.S. Treasury yields rising to near 19-year highs, putting pressure on the $32 trillion bond market. The U.S. Treasury announced that it would double the size of its repurchase operations of low-liquidity long-term bonds starting in September, with an additional $16 billion per quarter, and the amount of each operation increasing from approximately $2 billion to at least $4 billion.

However, the market's reaction quickly revealed the limitations of this operation. Peter Tchir of Academy Securities pointed out that the U.S. government currently has $7.5 trillion in short-term Treasury bills and $21.7 trillion in interest-bearing bonds in circulation. Bessant's $4 billion repurchases, almost weekly, are simply insufficient to sustainably shake the market. He judged that this is not quantitative easing; it is essentially just "rearranging the chairs on the deck" and does not actually create money.

Criticism from Wall Street followed. Greg Peters, co-chief investment officer of PGIM Credit, stated, "I have an extremely negative view of the Treasury's operating logic; it's a self-limiting, self-defeating strategy." Lisa Shalett, chief investment officer of Morgan Stanley Wealth Management, criticized the move, saying that intervening in the US Treasury market simply because of "annoyance" with rising yields "is not a convincing reason; it has a capricious feel to it." She added that if Bessant continues to attempt to control yields in the world's most important bond market, it would be tantamount to admitting Washington's concerns about debt sustainability.

Hedge fund billionaire Stanley Druckenmiller went even further, characterizing the move as a "mistake." In an op-ed published in the Wall Street Journal, he wrote:

"This is not liquidity management, it's price management—a mistake far more damaging than the $4 billion itself."

Warsh's stance is conflicting, and disagreements have also emerged within the FOMC.

Bessant's intervention directly impacted the core signal Warsh had consistently been sending to the market. Warsh had previously stated explicitly that rising yields reflected economic fundamentals requiring higher borrowing costs, and emphasized that the Federal Reserve, under his leadership, was "trying not to interfere with market signals." His core strategy was to guide investors to price assets based on economic data and market prices, rather than relying on forward guidance from the central bank.

This directly contradicts Bessant's logic. In an interview after the intervention, Bessant stated that the rise in yields "did not reflect fundamentals" and indicated that the Treasury had a "powerful toolbox."

Evercore ISI Vice President Krishna Guha pointed out that the Treasury's actions may not only unsettle investors, "but also some within the FOMC." He stated:

"Wash's core stance is irreconcilable with what the Treasury is doing. If the Treasury Secretary tells the market that prices are wrong and intervenes directly, it will be difficult for Warsh to appeal to the bond market's price discovery mechanism."

The internal divisions within the Federal Reserve cannot be ignored. Reports indicate that three members supported a rate hike at the July FOMC meeting. Subsequently, several regional Fed presidents publicly expressed support for a 25 basis point increase. The market currently prices in a 78% probability of a rate hike this year. Scott Barnard, a fixed-income portfolio manager at Westwood, stated that the combination of Warsh's abandonment of forward guidance and Bessant's intervention to suppress long-term yields has given the market the impression that the two institutions are "going their separate ways."

The market awaits Walsh's answer.

Warsh's speech on Friday carried weight beyond the framework of the Jackson Hole conference itself—this year's theme was "Financial Innovation: Its Implications for Payments and Policy," and did not directly address the path of monetary policy.

TD Securities U.S. interest rate strategist Molly Brooks warned, " If Warsh sticks to his old rhetoric, I think the market will be disappointed, which could exacerbate the long-term sell-off we've already seen." HSBC interest rate strategist Dhiraj Narula, however, believes Warsh has an opportunity to reassure the market through his rhetoric: "If Chairman Warsh can provide some characterization of potential inflationary pressures, that would be enough to justify reducing the uncertainty-related term premium."

Mark Cabana, head of U.S. interest rate strategy at Bank of America Global Research, said that Warsh's "firm commitment" to lowering inflation is far from enough for the market. "We need to hear concrete plans from the Fed on how to push inflation down in the face of persistent underperformance." The latest U.S. inflation reading is 3.7%, having been above the 2% target for more than five consecutive years.

Michael Ball, a strategist at Bloomberg Markets Live, points out that while Bessant can adjust the debt maturity structure, only the Federal Reserve can anchor inflation expectations. Warsh's Jackson Hole speech must reiterate that the 2% target is still achievable and clearly state that if inflation persists, policy action will be taken, even at the cost of friction with the administration.

Ahead of his Jackson Hole speech, the market will also see the release of July's Personal Consumption Expenditures (PCE) data on Wednesday. Over the past month, inflation, employment, and retail sales data have all been in line with or below expectations, prompting traders to lower their near-term interest rate hike expectations. If the PCE continues this trend, it may provide some buffer for Warsh's speech.

The shadow of "fiscal dominance" casts a test on independence.

The deeper concern stemming from Bessant's failed intervention lies in whether the Federal Reserve will be drawn into the situation. The Trump administration's political intention to lower borrowing costs ahead of the November midterm elections has significantly increased market scrutiny of the Fed's independence.

Jason Furman, a Harvard University professor and former chairman of the White House Council of Economic Advisers, stated:

"If the Federal Reserve takes debt management objectives into account when formulating monetary policy, it will have a fiscal-led implication."

Discussions surrounding policy coordination are also heating up in the market. Some analysts have suggested that the Federal Reserve could sell its approximately $426 billion in short-term bonds and instead purchase an equivalent nominal amount of long-term bonds with maturities of 20 years or more, essentially emulating the "Operation Twist" model. This operation would not change the Fed's total bond holdings on paper, would be more politically acceptable, and could absorb more than 15% of the circulating supply of bonds with maturities of 20 years or more, effectively suppressing long-term yields.

However, Bloomberg analysis points out that this combination of measures contains an inherent contradiction: the higher the proportion of short-term financing, the greater the Treasury's exposure to policy rates. Once inflation forces the Fed to raise rates, interest costs will be reset more quickly; if the Fed hesitates due to concerns about fiscal costs, the market will punish its independence with a higher term premium.

It's worth noting that Warsh and Bessett are both protégés of hedge fund billionaire Stanley Druckenmiller, and reportedly meet regularly and have a harmonious relationship. However, investors and economists generally point out that the priorities and operational logics of their respective institutions are becoming increasingly incompatible. The 5% yield on 30-year US Treasury bonds is considered a key level, and Warsh's remarks this Friday will determine how the market prices this policy rift.

Risk warning and disclaimerInvesting involves risk; please exercise caution. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Any investment decisions made based on this information are at your own risk.