Original Title: JPMorgan Slams Bessent's Bond Market Intervention: Market Will View Treasury As 「Lacking Credibility」
Original Author: Tyler Durden
Translation: Peggy

Editor's Note: On August 19, the U.S. Treasury unexpectedly announced that it would increase the single-issue cap for the liquidity support repurchase of 10-20 year and 20-30 year nominal Treasury bonds from $20 billion to at least $40 billion. The new arrangement will take effect from September 9. After the news was released, the long-end Treasury yields briefly dropped by around 9 basis points, and the yield curve noticeably flattened.

However, the market quickly shifted back to selling. The next day, the 10-year Treasury yield briefly rose to 4.71%, and the 30-year yield approached its previous high. This prompted the market to start questioning: If the repurchase size is relatively limited and has not yet been implemented, why did the Treasury choose to make an interim adjustment to the plan just two weeks after the quarterly refunding announcement?

ZeroHedge cited a report from JPMorgan's interest rate strategist Jay Barry, suggesting that the Treasury may not be addressing market liquidity dysfunction but rather expressing concerns about the rise in long-term yields. JPMorgan is not so much concerned about the $40 billion repurchase itself, but rather whether the Treasury is deviating from "conventional and predictable" debt management practices towards a more opportunistic approach to maturity and issuance management.

This distinction is crucial for the long-term pricing of Treasurys. If investors believe the Treasury is trying to use repurchases or reduce long-term debt supply to lower financing costs without simultaneously improving the fiscal deficit, the downward pressure on short-term yields may not be sustainable. Instead, it could potentially raise term premiums, increasing the cost of long-term borrowing.

Below is the translation of the original text:

The U.S. Treasury's expansion of long-term Treasury bond repurchases initially received a positive market response.

The Treasury announced that it would increase the size of the single-issue liquidity support repurchase for 10-20 year and 20-30 year nominal Treasury bonds from a maximum of $20 billion to at least $40 billion. According to the Treasury's announcement, the new size will be effective starting from September 9, rather than immediately entering the market to buy bonds on the day of the announcement.

After the news was released, long-end Treasury yields dropped by around 9 basis points, and the yield curve showed a similar degree of flattening. However, this market trend did not last long. The next day, the 10-year Treasury yield briefly rose to 4.71%, essentially reversing the previous downward movement post-announcement.

JPMorgan Chase believes that the most noteworthy aspect of this repo adjustment is not the size, but the timing: the Treasury Department had just released a tentative repo schedule for the next three months in its August 5 quarterly refunding announcement, where the single-dated limit for 10-20-year and 20-30-year Treasury bonds was still $20 billion.

With No Clear Market Dysfunction, Why Did the Treasury Department Make a Last-Minute Adjustment?

U.S. Treasury bond repos are mainly divided into two types: cash management repos and liquidity support repos.

This adjustment targeted the latter. By conducting repos on less liquid off-the-run securities, i.e., Treasury bonds issued in previous auction rounds, the Treasury aims to enhance trading efficiency between different securities and provide market participants with predictable exit options.

Under this mechanism, the key consideration for determining whether to increase the repo size should typically be whether market liquidity is deteriorating.

Referencing the assessment framework proposed by the Treasury Borrowing Advisory Committee, JPMorgan Chase examined repo bid sizes, Treasury curve dislocations, and valuation gaps between on-the-run and off-the-run securities. The conclusion was that the relevant metrics for the 10-20-year and 20-30-year Treasury bonds remained close to the average levels of the past year, showing no significant signs of market dysfunction.

The report stated that the pricing dislocation of off-the-run securities relative to the fitted yield curve remained stable, significantly below extreme levels seen in the past five years; the asset swap spread between on-the-run and off-the-run securities also did not exhibit major divergences. Overall, the operation of the Treasury market this year has even improved.

Therefore, JPMorgan Chase interprets this temporary adjustment as a policy signal: the Treasury Department's concern may not be liquidity but rather long-term yields themselves.

The Treasury Department May Be Forming a New Long-End "Reaction Function"

JPMorgan Chase believes that there may be a common theme underlying recent policy actions—the Treasury Department's increased sensitivity to rising long-term yields.

This involves a commonly used market concept: the reaction function, which is an unofficial rule where investors infer what actions policymakers might take under certain conditions based on their past statements and actions.

In JPMorgan Chase's view, the Treasury Department's decision to announce repo adjustments a few hours before the 20-year Treasury bond auction and a day before the 30-year Treasury Inflation-Protected Securities auction may indicate its desire to alleviate long-end funding pressures. However, this is still an analyst's interpretation of policy intent and not a confirmed policy objective by the Treasury Department.

The report also points out that this year, U.S. bond yields rose, a large part of which can be explained by the market's hawkish repricing of the Fed's policy path. According to J.P. Morgan's fair value model, the 10-year yield has not significantly deviated from fundamentals.

What has truly shown a deviation is the longer end of the yield curve. Global long-term bond yields have generally risen, particularly with the surge in Japanese long-term government bond yields, weakening the relative attractiveness of U.S. bonds to some foreign investors.

During Japan's implementation of a negative interest rate policy and yield curve control, U.S. bond yields, after currency hedging, were more attractive than Japanese government bonds, helping to suppress U.S. long-end rates. Now, this mechanism is partially reversing: Japanese long-term rates are rising, which could reduce the incentive for Japanese investors to allocate funds to U.S. bonds and amplify upward pressure on the U.S. yield curve's longer end.

Repo Operations Address Symptoms, Deficits Drive the Tenor Premium

J.P. Morgan's most significant criticism of the Treasury's strategy is that repo operations can alleviate short-term pressures in the long bond market but cannot alter the fiscal backdrop of continuously increasing U.S. bond supply.

The report anticipates that the U.S. financing gap over the next several fiscal years could exceed $3.5 trillion. In this environment, the Treasury may ultimately need to offer more duration to the market rather than less. Even if the Treasury reduces the size of long bond auctions, it will only shift financing requirements to other tenors without making overall borrowing needs disappear.

J.P. Morgan also notes that there has been no demand collapse in long bond auctions. End investors' participation in 30-year Treasuries is at a record high for the year, and demand for 20-year bonds is also close to historical highs. This further undermines the explanation that "temporary ramp-up repos are necessary to improve market functioning."

The more underlying issue remains the fiscal deficit. J.P. Morgan describes the current fiscal situation with a deficit of about 6% of GDP; the U.S. Congressional Budget Office's February benchmark forecast for the 2026 fiscal year deficit is $1.9 trillion, approximately 5.8% of GDP, with both figures being broadly similar.

The report suggests that without substantial fiscal consolidation, the market may view more flexible and opportunistic debt management as lacking credibility. If the Treasury further deviates from the "conventional and predictable" issuance principles, investors may demand a higher tenor premium to compensate for future supply, inflation, and policy uncertainty.

This implies that an operation aimed at lowering long-end rates may, in the long run, carry the risk of raising yields. However, this is still a risk scenario proposed by J.P. Morgan, not an outcome that has already occurred.

UK Experience: Adjusting Long Bond Supply, Impact Often Diminishing

To assess whether the sustained reduction in long-dated bond supply can continue to depress yields, J.P. Morgan has referenced the UK's experience.

The UK has reduced the proportion of long-term gilts to net issuance from an expected 28.4% in April 2022 to the current 9.1%. Over the past four years, the UK Debt Management Office has adjusted the share of long-dated bond issuance 12 times.

These adjustments typically manage to flatten the yield curve in the short term. J.P. Morgan estimates that within five days of the announcement, the spread between UK 5-year and 30-year gilt yields has narrowed by an average of around 2 basis points; looking at a ten-day window around the announcement, the average narrowing is about 5 basis points.

However, this impact is not long-lasting, and with repeated similar operations, the uplifting effect on the long end of the gilt curve diminishes over time. Despite the UK base rate dropping 175 basis points from its cyclical peak, long UK gilt yields remain near multi-decade highs.

Based on this assessment, J.P. Morgan believes that expanding repos or reducing long-dated bond issuance in the US may also temporarily lower long-end yields but could struggle to alter the longer-term trajectory. Unless the fiscal deficit narrows concurrently, structural supply adjustments are unlikely to be a stable tool for lowering funding costs.

Going forward, the market needs to observe not only whether the Treasury continues to increase repo sizes but also whether it reduces the auction sizes of 20-year and 30-year bonds, as well as whether significant changes occur in the fiscal deficit, foreign demand, and term premium.

If long-end yields continue to rise after repo implementation, or if each policy adjustment leads to a shorter and shorter market reaction, it would support J.P. Morgan's view that "debt management cannot substitute for fiscal rectitude." Conversely, if market liquidity metrics significantly deteriorate while repos continue to enhance trading efficiency, then this adjustment is more likely to be seen as a technical operation rather than a direct attempt by the Treasury to control long-end rates.

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