Market Outlook

September 1, 2026

Gov’t Bonds May Suffer If Fed And Treasury Are Discordant

The U.S. bond market appears to be at an inflection point. Not only because the country is $40 trillion in the red but, more immediately, because the central bank (the Fed) and the Treasury seem poised to work at cross-purposes.

Late in August, Treasury Secretary Scott Bessent saw the need to do two things: issue more debt so the government can pay its bills (he’s got no choice there), and bring down long-term interest rates. While both are very important, let’s focus on the latter.

The combination of record-high government borrowing plus AI-related corporate bond issuance drove the yield on the 30-year (long) bond to 5.31% on August 17. It hasn’t been that high since the Financial Crisis. Finishing the month up nine basis points (bps) to 5.25%, that’s 41 bps higher since the start of the year. During that same 8-month period, 5-year and benchmark 10-year Notes have risen even more, 85 and 55 bps, respectively, to 4.49% and 4.75%

While the stock market has so far had only a muted response from rates, there’s little doubt that elevated borrowing costs (and energy prices) are slowing the economy.

Indeed, second-quarter GDP growth was an anemic 1.5%. Higher rates are one of several headwinds for many parts of the economy, including industrials, housing, construction, and smaller companies that are reliant on financing. Ditto for credit-card-dependent individuals and families. It wasn’t lost on the markets that second-quarter sales growth slowed at bellwether Walmart to 2.6%. That was its slowest pace in six years. The market’s immediate reaction was to send its share price down 8.9%. Meanwhile, some economists say it signals trouble for middle-class consumer spending.

Appreciating that higher borrowing costs are constricting economic growth while being perilous to the government’s ability to pay its creditors, Treasury Secretary Bessent announced a modest bond buyback program. At first, it was so small that it backfired.

But now he says the Treasury is prepared to tap as much as $1 trillion in the Treasury General Account to buy longer-dated (10- to 30-year) bonds using newly issued shorter-dated T-bills whose interest rates are lower.

This slight-of-hand is known as a Treasury Twist. It doesn’t actually lower indebtedness per se; it only makes it a bit more manageable in the short term. The plan’s real goal is to bring down long-term interest rates and spark economic growth.

As noted, the market’s reaction was skepticism. However, the reaction from his former boss, Stanley Druckenmiller (Bessent’s former mentor at George Soros’s hedge fund), was to take Bessent to the woodshed. In a widely discussed Wall Street Journal editorial, he criticized the Treasury secretary for market manipulation and masking the real reason interest rates have trended higher: the $40 trillion debt.

Having inherited a Fed Funds rate of 3.50% to 3.75%, new Chair Warsh may be anxious to make his own mark by providing less rate-guidance, while also embracing Fed-speak: his jargon telegraphed confusion at Jackson Hole last week. Regardless, Warsh has a problem: Inflation has been stuck well above 2%, a target that he’s embraced. Core PCE (the Fed’s favored inflation gauge) has been above that level since March 2021 (it’s now 3.3% versus headline CPI inflation of 3.4%). Meanwhile, the market has priced-in one 25-basis-point hike for this year. (It has three opportunities to hike in the remaining months of the year.)

In so doing, short-term rates will, of course, rise. But that might present a problem for Bessent’s "Twist," whose success is predicated on the Treasury’s ability to refinance longer-dated bonds with higher rates for shorter-dated ones at today’s lower rates. And that might lead to another problem if inflation doesn’t slow: with a larger balance sheet of shorter-dated bills and notes, the Treasury will have a shorter window in which to reinvest trillions of short-term debt at rates that are elevated from today’s level.

The biggest potential problem with the Treasury and Fed moving at cross-purposes is that the Treasury’s actions could at least partially undo the Fed’s inflation-fighting end-game.

While there’s a certain degree of math and mechanics that drive bond pricing, all markets are ultimately driven by people. So far, few in government have a plan, let alone interest, in right-sizing our $40 trillion hole. We’re not growing our way out of it, and shuffling deck chairs is no solution. But the truth of the matter is that the most responsible way for the country to lower the cost of borrowing is "simply" to spend and borrow less.

— John Bonnanzio