With U.S. debt hitting $40 trillion, markets are turning more attention to that burden and whether policymakers will address the root causes or just the symptoms.
The Treasury Department’s interventions in the bond and currency markets in recent weeks point to the latter.
Treasury Secretary Scott Bessent surprised Wall Street on Wednesday with a plan to increase buybacks of long-term bonds, after the 30-year yield hit the highest level in nearly 20 years.
That came just a few weeks after the U.S. and Japan took such joint action to boost the yen for the first time in three decades. But to make it happen, the U.S. sold euros instead of dollar-denominated assets, avoiding a sale of Treasury securities that would put more upward pressure on yields.
Japan also refrained from selling Treasuries and instead tapped an obscure Federal Reserve tool called the Foreign and International Monetary Authorities Repo Facility (FIMA). This mechanism allowed Japan, which is the world’s largest holder of U.S. debt, to borrow dollars against its Treasury stockpile, obtaining a limited form of liquidity.
According to George Saravelos, head of FX research at Deutsche Bank, “we see both the buyback and encouragement to use the FIMA facility for FX reserves as soft-form financial repression policies aimed at containing the long-end of the US yield curve.”
Financial repression generally refers to policies that enable a government to keep interest rates artificially low by influencing financial markets.
Countries throughout history have practiced it, especially during times of high indebtedness. In fact, the U.S. and other developed economies used financial repression to slash their debt-to-GDP ratios after World War II.
Indeed, conflict and calamities are major factors in financial repression. A recent survey of 300 years of U.S. and U.K. history found that wars are “always disaster times” for holders of government debt because of inflation and financial repression.
It’s not good for currencies either. Saravelos warned that suppressing U.S. Treasury yields will merely shift the impact to the dollar.
“If the market price of USTs is not ‘allowed’ to adjust down, the foreign exchange price of UST owned by foreign investors has to adjust via a weakening in the dollar,” he explained.
Markets will next scrutinize how the Federal Reserve responds, Saravelos predicted, pointing out that Bessent’s moves to effectively loosen financial conditions would typically prompt the Fed to offset that with tightening measures.
That’s as the Fed has been especially wary of inflation, which has exceeded its 2% target for more than five years, with several central bankers ready to hike rates. But Chairman Kevin Warsh has refrained from so-called forward guidance, leaving Wall Street guessing on his stance.
“If Chair Warsh does not recognize the buyback as a factor driving an easing of financial conditions, we would take it as an additional dollar negative driver,” Saravelos added. “In all, the market is likely to be increasingly attentive to further measures intended to support the US Treasury market going forward. The more these are perceived as distortionary to market pricing, the more the dollar is likely to weaken.”
Since the debt buyback was unveiled, markets have ramped up bets on the “debasement trade,” with prices for gold and bitcoin surging on expectations of further dollar devaluation.
That’s because the root causes of the recent jump in bond yields—especially massive debt and deficits—are not priorities among most lawmakers.
The federal budget deficit is on track to hit $2 trillion this fiscal year, and debt interest costs alone are already $1 trillion annually, taking up a bigger and bigger share of spending. But there’s no sign Washington is serious about slashing the budget or raising taxes.
Absent such moves, the solution to higher borrowing costs is likely more repression. A research paper last month from the International Monetary Fund said the world is ripe for another wave.
“With the conditions historically associated with elevated repression present today, our evidence suggests that financial repression may see increased use going forward,” it said.
