Market Faith in Fed Credibility Exposes Trump Administration's Debt Management Flaw

The recent surge in US borrowing costs can be attributed to various factors, including inflation, budget deficits, and strong economic growth. However, a closer look at the yield curve reveals that Federal Reserve Chair Kevin Warsh's hawkish stance is gaining credibility among market participants.

Since Warsh's speech in Jackson Hole, Wyoming, real yields for short- and medium-term Treasuries have increased by 0.57 percentage point and 0.64 percentage point, respectively. This suggests that the market expects the Fed to lift rates meaningfully in the coming months to secure its 2% inflation goal.

The break-even rate, a proxy for inflation concerns, has barely budged, indicating that unchecked inflation is not the dominant driver of this move. Longer-term US bonds have also moved, but less than shorter-maturity debt, undermining the idea that shifting growth estimates or deficit concerns are driving investors' decisions.

Treasury Secretary Scott Bessent's strategy for funding the budget deficit through short-term debt has been exposed as flawed. By leaning on bills and buying back existing long-dated securities, he temporarily capped longer-term bond sales to suppress yields. However, this move is no longer tenable with rising interest rates.