The US Treasury wants lower bond yields. But will it work?

Saad (0:01)

Hello folks, you're tuned in to Finshots Daily. I'm Saad, and if you're new, you're welcome. If you're returning, welcome back. In today's episode, we explain what the US Treasury is doing with bonds, and why it doesn't seem to be working as intended.

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Last month, the US Treasury announced that it would expand the buyback program for its own long-term bonds. But this isn't anything new. The Treasury keeps buying back bonds. What was different this time was that it said it would double the size of its buyback. So if it normally bought $2 billion worth of long-term bonds each week, it would now buy back $4 billion or more for a few months.

We are saying more because 30-year Treasury yields or the interest rates had touched 5.13% last month, their highest level since the 2008 financial crisis. And because these yields affect borrowing costs across the US economy, Treasury Secretary Scott Besant had signaled larger buybacks to help tame borrowing costs. Basically, when there's a large buy for long-term bonds, bond prices rise and yields fall. That's because bond prices and yields move in opposite directions. If prices rise, yields fall. If prices fall, yields rise. And the Treasury believed that this larger buyback would bring down yields and provide liquidity to older long-term bonds which can become harder to trade. The logic is simple. When new bonds come in, investors tend to focus on them while older bonds see less trading. So with fewer buyers and sellers for old, long-dated Treasury bonds, the market becomes less liquid. The announcement immediately brought 30-year bond yields down to 5.19%.

But last week, when the actual size of the larger buyback was announced, 30-year bond yields climbed back up to 5.29%.

That's because investors expected the US Treasury to buy back at least 10 billion dollars worth of long-dated bonds. But the actual size came in at about just 6 billion dollars. Sure, it was larger than the 4 billion dollars that the Treasury had promised. But here's the thing, bond yields have also been rising because of global uncertainty, including inflation fears from tariffs and the US-Iran war, as well as oil prices topping at 100 dollars a barrel. So investors assumed the Treasury would buy even more long-dated bonds than promised. When that didn't happen, yields started climbing again. Now, what we told you so far is just the context. But buyback expectations aren't the only reason why 30-year Treasury bond yields went back up. There's more to it. So let's break it down. First, let's start with how two institutions, the US Treasury and the Federal Reserve influence interest rates, which in turn decide how much a borrower in the US or indirectly worldwide pays for long-term loans such as mortgages, bonds and private credit. The Federal Reserve or simply the Fed is the US Central Bank. One of its main jobs is setting a target rate for the interest rate banks charge each other for loans. This figure ripples through the economy because other interest rates such as those for credit cards, business loans and savings accounts are priced relative to it. So when the Fed raises or lowers this rate, it influences the cost of borrowing everywhere. But here's another tool at the Fed's disposal, quantitative easing or QE. This is when the Fed creates new money and uses it to buy long-term bonds. The US Treasury, on the other hand, has a completely different job. It's the government's accountant and borrower. It doesn't set interest rates. Instead, it manages how the government borrows money to fund its spending. Its tools include deciding how much debt to issue, what maturities to issue it in, like short-term bills or long-term bonds, and occasionally buying some of its own older bonds back. Now, the bonds it issues are considered one of the safest investments, almost risk-free, in the entire world, backed by the full faith and credit of the US government. And because they're considered so safe, they offer relatively low interest rates. That means Treasury yields affect things like home and corporate loans. So when lenders price these loans, they start with Treasury yield, the risk-free rate, plus a spread to compensate for the extra risk of lending to these borrowers. That's why the US Treasury wants to buy old bonds back, to support bond prices, lower yields, and in turn, borrowing costs. But remember, unlike the Fed does with QE, the Treasury cannot create new money. So, every dollar it uses for a buyback has to come from money it has raised elsewhere. With this in mind, let's apply this mechanism to the situation in question. The Treasury is buying back old long-term bonds, with 10-30 years left to mature, to improve liquidity. That should push yields down. But where is this new money coming from? Well, it can't print new money like the Fed, so it has to borrow money elsewhere to fund its buyback, like from issuing more short-term Treasury bills. And more reliance on short-term bills means the Treasury has to keep refinancing them at whatever new rate the market demands. So if short-term rates spike, borrowing costs jump too. That means it's not really solving the problem. It's just swapping one type of debt for another. So it doesn't do much to help push rates down, even though yields fell immediately after the Treasury announced the larger buyback, largely because of investor expectations. There's another thing to look at too, the size of this so-called larger buyback. See, we know it sounds huge, but if you look closely, it's actually tiny. Think about it. The entire 10 to 30-year US Treasury bond market that the Treasury is targeting is worth about $5.5 trillion, and last week's buyback was $6 billion.