Weekly bond market update: Treasury twist—Treating the symptom, not the disease
Treasury’s latest move may improve trading conditions, but it is unlikely to reverse the rise in long-term borrowing costs without stronger fiscal discipline and clearer signals from the Federal Reserve.
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At a Glance
- The US Treasury’s decision to increase long-end buybacks should improve market liquidity, but the amounts remain too small to reverse the broader rise in long-term yields.
- The Treasury Department and the Fed have several tools to reduce duration pressure, including changes to issuance, reinvestments and potentially an Operation Twist-style program. These measures can buy time, but they cannot restore fiscal credibility.
- Paradoxically, the greatest support for the long end may come from a Fed willing to tighten policy if necessary, reinforcing inflation credibility and demonstrating its independence from Treasury’s financing needs.
- Fixed income continues to offer attractive value, but we prefer the 5-to-10-year part of the curve, curve steepeners, Agency MBS, taxable municipals and selective EM debt over long-duration Treasuries and broad corporate exposure.
Bond markets have moved front and center ahead of Federal Reserve (Fed) Chair Kevin Warsh’s speech at the Jackson Hole Economic Policy Symposium on Friday. On August 19, the Treasury Department announced that it would increase the maximum size of long-end liquidity-support buybacks from $2 billion to at least $4 billion per operation, effective September 9. The 30-year yield initially fell around 10 basis points before surrendering most of the move. The market’s verdict was clear: the move might be helpful for liquidity, but it is probably too small to change the broader direction of yields.
To have a greater impact, Treasury could expand buybacks and temporarily fund them from the nearly $1 trillion held in the Treasury General Account (TGA)—effectively the government’s checking account at the Fed—rather than immediately issuing replacement debt. It could also shift issuance toward bills, reduce long-dated auction sizes or reconsider the 20-year bond. These measures would remove duration and add reserves, although the usable TGA balance is limited and any drawdown would eventually need to be rebuilt. A sustained effect on yields would probably require a separate Federal Open Market Committee decision through adjusted reinvestments or an Operation Twist-style program. Investors will therefore be listening for any indication that the Fed is prepared to complement Treasury’s actions.
The main problem remains fiscal
The US does not necessarily have an interest-rate problem. The 10-year Treasury has remained broadly within a 4–5% range for nearly three years, and today’s yields are not unusual historically. It is the near-zero-rate environment following the global financial crisis that increasingly looks like the anomaly.
The problem is that debt and structural deficits expanded dramatically during more than a decade of artificially cheap financing. Rates that once appeared unremarkable are now placing considerable strain on the public finances. Net interest has risen from around 8% of federal revenue in 2021 to almost 20% today and has overtaken defense spending, reducing fiscal flexibility at a time when geopolitical pressures are increasing demands on the defense budget.
Figure 1: Net interest cost has risen to 20% of federal revenue
US net interest cost versus 10-year yield
Source: Bloomberg, Schroders, as of 8/25/26.
For much of the post-Global Financial Crisis period, low rates and central-bank purchases insulated Congress from the market consequences of persistent deficits. After years in which politics failed to provide a fiscal brake, the bond market may finally be applying one. The Fed could ultimately go further through formal yield-curve control. Beginning in 1942, it capped long-term Treasury yields at 2.5%, thereby reducing financing costs but expanding its balance sheet, constraining its independence and adding to inflationary pressure alongside wartime fiscal expansion. Those tensions ultimately culminated in the 1951 Treasury–Fed Accord.
Today’s measures remain far removed from that experience, but the lesson is relevant: suppressing bond yields does not eliminate the fiscal imbalance; it merely changes where the pressure appears. The adjustment may instead come through a weaker dollar, higher inflation and lower real returns for bondholders. Policymakers can redirect that pressure, but they cannot make it disappear. The disease is not 5% yields; it is a fiscal position built for near-zero rates that has become increasingly difficult to sustain under normal rates.
Jackson Hole becomes the key test
Warsh’s most important task on Friday will be to restore clarity following the confusing press conference he held after the last FOMC meeting. Markets need a clearer reaction function: how the Fed is weighing improving inflation against the risk of renewed price pressures, and what conditions—such as reaccelerating inflation, renewed labor-market strength or excessively easy financial conditions—would prompt another rate increase. The credibility gap left by the last meeting contributed to pressure on the long end.
Paradoxically, a credible willingness to raise rates, if necessary, may support the long end by strengthening the dollar and reinforcing the Fed’s inflation credibility and independence. Investors will also listen for any indication that the Fed might complement Treasury’s actions through adjusted reinvestments or an Operation Twist-style program. Warsh need not pre-commit, but he should explain where those tools fit within the Fed’s reaction function. His message may determine whether Treasury Secretary Scott Bessent’s announcement remains a modest liquidity operation or becomes part of a broader policy response.
Fixed income offers good value but still requires selectivity
Despite the risks at the long end, we believe bonds offer excellent value for long-term investors. We expect the 10-year Treasury to remain broadly within a 4–5% range, providing attractive carry, although fiscal uncertainty leaves the 30-year vulnerable. We therefore prefer the 5-to-10-year part of the curve and curve steepeners over a large outright duration position. Corporate spreads remain expensive, but we see selective value in banks, energy and pipelines, utilities and well-structured hyperscaler debt. We prefer agency mortgage-backed securities (MBS), specified pools, agency planned amortization class bonds (PACs) and taxable municipals for attractive carry with less credit risk, alongside selective emerging-market exposure in Brazil and Mexico. We remain confident that the best opportunities remain in carry, structure and security selection—not indiscriminate exposure to credit or the long end.
Read the team’s latest quarterly market outlook: Fixed income markets now demand a mix of tactical offense and resilient defense.
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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.
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