[This blog post is an excerpt from a recent commentary at https://speculative-investor.com/]

Many articles and internet posts have referred to the decision by US Treasury Secretary Scott Bessent to double the dollar value of US government debt buybacks from US$2B to US$4B per auction as the “Bessent Put”. The implication is that the US Treasury is trying, via its buybacks, to put a floor under long-term government bond prices, or, looking at it from a different angle, to cap long-term interest rates. This is partly true, but most of the articles we’ve read contain a lot of misinformation. Here are two important considerations/misunderstandings.

First, the assertion that the US Treasury is replacing relatively-low-cost debt with relatively-high-cost debt is wrong or at best misleading. While it is true that the interest rate on the bonds that are repurchased will be much lower than the interest rate on the newly issued debt, the fact that the old debt will be repurchased at a large discount to par means that the cost-to-maturity for the Treasury will not necessarily change. This is because an increase in the interest paid will be offset by a reduction in the principal owed.

Second, what the US treasury is doing is very different from the Yield Curve Control (YCC) carried out by Japan’s monetary authorities. In Japan, the central bank added bonds to its balance sheet (purchased bonds using newly-created bank reserves) to keep bond yields within a certain range. In the US case, however, the central bank has no involvement and the Treasury finances the purchase of old debt by issuing new debt, meaning that there is no creation of additional bank reserves.

The debt buybacks make sense because they address a problem without adding to the US government’s debt burden. The problem they address is that due to interest rates being much higher now than they were several years ago, there are now a lot of bonds on the balance sheets of financial institutions that have become illiquid (these days, nobody wants to own government bonds with sub-2% yields). Furthermore, passive investing is exacerbating the problem, because the lower a bond’s price becomes, the smaller the amount of money that will be allocated to its purchase by passive bond funds*. By replacing this old debt that trades at a large discount with new debt that trades at par, the Treasury simultaneously reliquefies the bond market and reduces the downward pressure on bond prices being exerted by passive investing strategies.

The risk is that by replacing old long-term debt with new short-term debt, the US federal government’s finances become more sensitive to changes in short-term interest rates. In other words, the buybacks will make the government’s financial health more vulnerable to Fed rate hikes. Therefore, it’s likely that in the future even greater political pressure will be brought to bear on the Fed to cut its targeted short-term interest rates.

Bessent’s buyback scheme will not address the main problem, which is that the US government continues to do nothing meaningful to reduce its massive annual budget deficit. On the contrary, both major US political parties agree that the government should do (spend) more, with the only disagreements being over the details. Therefore, the scheme will not end the long-term bear market in government bonds. However, despite the small dollar value currently involved, there’s a good chance that it will work in the short-to-intermediate-term by adding liquidity to the financial markets and removing some of the downward pressure on bond prices.

*It’s the opposite situation to the stock market. In effect, passive investing creates a positive feedback loop, in that it tends to magnify up-moves in securities that are becoming relatively expensive and down-moves in securities that are becoming relatively cheap.