Band-Aid on a bullet hole
The major headline last week was the U.S. Department of the Treasury’s announcement on Wednesday of larger long-end Treasury buybacks. Specifically, “the Treasury is increasing, by at least double, the size of liquidity support buyback operations for longer-dated nominal coupon securities (the 10-year to 30-year sector). The current maximum size of $2 billion per operation will be at least $4 billion per operation.” The upsize would take the already planned $38 billion this quarter to approximately $52 billion.
The initial market reaction included a bid for Treasuries that sent yields seven to 10 basis points lower on the backing of Treasury Secretary Scott Bessent. But the remainder of the week was marked by retracement higher, as bond investors refocused on fundamental macro issues such as the magnitude of U.S. deficit spending and ongoing inflation above target.
With the Treasury’s announcement, Bessent tried to send a signal that losing control of the long end of the U.S. yield curve is a non-starter and that further intervention remains on the table. The current Treasury buyback program is also designed to be deficit and current cash neutral by retiring on-the-run, long maturity Treasury debt with proceeds from issuance somewhere else on the maturity spectrum. The difficult question is what happens if, and likely when, that effort is insufficient, which could force a larger policy response.
Neither quantitative easing nor yield curve control are new, yet a return to either would require a meaningful deterioration in conditions. The sheer magnitude of the deficit, combined with future funding needs, oil-linked inflation risk, and broader borrowing pressures, could potentially be that catalyst. But even if policymakers returned to quantitative easing or yield-curve control, those measures would ease the pressure without addressing the underlying fiscal imbalance. As country star Morgan Wallen sang, it would be “like tryna put a Band-Aid on a bullet hole.”
Ian Lyngen, a rate strategist at BMO, commented that the “outright level of nominal yields will be largely a function of inflation and growth expectations.” For now, though, growth appears positive but not overly robust, and inflation seems to be waning, albeit with upside risks. Rates, however, are breaching multi-decade highs even in the aftermath of the Treasury announcement. That rates rose after the buyback, despite a broadly satisfactory growth and inflation backdrop, may point back to Washington. “As a theme,” Lyngen continued, “the market tends to emphasize the fiscal side when the underlying economy is stable. Said differently, investors have the luxury of trading off of issuance projections and borrowing needs as long as the economy isn’t at risk of a recession and equity valuations are on solid footing.” He added that “the fiscal side matters at extremes.” It increasingly appears that the market may be testing one such extreme, as 30-year real yields approach 5.30%, matching levels last experienced roughly two decades ago (Figure 1).
Just hours after Bessent’s buyback announcement, the Treasury Department also announced that the national debt breached $40 trillion. The eye-watering level has grown exponentially in recent years, as ever more polarized lawmakers in Washington shrug off fiscal responsibility. According to Maya MacGuineas, President of the Committee for a Responsible Federal Budget, a nonpartisan think tank, over the first 241 years of U.S. history—a period that included two world wars, the Great Depression, and the Great Recession, among other crises—the country accumulated $20 trillion of outstanding federal debt. But America added the next $20 trillion in just the past nine years, with $1 trillion added since March alone (Figure 2).
Analysis compiled by Deutsche Bank economists shows that multiple administrations contributed to the recent exponential deficit growth, notably:
- Tax cuts during George W. Bush’s presidency in the early 2000s are estimated to have reduced revenues by $3.3 trillion through the mid-2010s.
- Tax cut passed in 2017 during the first Trump administration reduced revenues by at least another $1.5 trillion over the past decade.
- Spending on wars in Iraq and Afghanistan cost taxpayers over $1.6 trillion through the mid-2010s.
- Although the impact of the Affordable Care Act enacted during the Obama presidency is debated, with some estimates showing a reduction in deficits, other analysis suggests that the legislation added about $500 billion to U.S. debt over the ensuing decade.
- The American Rescue Plan Act of 2021 during the Biden presidency is estimated to have increased deficits by $1.9 trillion over a decade, excluding interest costs.
- Trump’s One Big Beautiful Bill Act is forecast to increase the primary deficit by $3.4 trillion over a 10-year period, according to the Congressional Budget Office. When including additional net interest and debt-servicing costs, the total deficit impact is estimated to be over $4 trillion.
- Current uncertainty around increased defense spending associated with the Iran war remains an additional fiscal pressure point.
Michael Peterson, president and CEO of the nonpartisan Peterson Foundation, summed it up this way: “It’s not just troubling that the debt and disfunction in Washington keeps growing but that the deficit is growing so quickly and hitting a new high during a period of relative prosperity. We’re not in the middle of a world war or global pandemic, and yet the federal government is still running a deficit in excess of $2 trillion at a time when Washington should be trying to improve its finances so it would be better prepared for the next crisis.”
Matthew Luzzetti, chief U.S. economist at Deutsche Bank AG, took the cumulative debt announcement in stride: “Optically, I’m sure crossing thresholds like $40 trillion will focus attention on the issue in the near term. But it does not represent a magical threshold for debt dynamics, and projections have anticipated this outcome for some time.” Still, higher yields, combined with rising debt, create a vicious cycle for the Treasury Department, by increasing interest costs and potentially fueling the need for additional borrowing.
For example, the current year-to-date interest cost on Treasury debt outstanding amounts to $1.17 trillion, a 15% increase, year over year, on the third-largest part of the federal budget after healthcare and Social Security. “We are skeptical the administration can realistically do anything at this point on the deficit that would be material,” Sarah Bianchi, chief strategist at Evercore ISI, wrote in a note last Thursday. Indeed, Republicans have long opposed tax increases, Democrats have resisted spending cuts, and both Republicans and Democrats have largely opposed reforms to Social Security and Medicare—the main long-term drivers of U.S. deficits and debt.
Various market factors are also creating headwinds for Bessent’s desire for lower Treasury rates. First, the U.S. dollar has weakened (Figure 3), and a second-order effect of a softer greenback can be higher import-price inflation. For a nation running a trade deficit of approximately $73 billion as of June, a weaker dollar implies that overseas goods cost more in dollar terms, effectively importing additional inflation pressure.
Second, massive corporate bond issuance is crowding out typical Treasury duration buyers: Corporate issuance is up 59%, while total investment grade supply, year to date, is $1.77 trillion, according to Nomura strategist Charlie McElligott. Investment grade issuance is on pace to hit an all-time high by the end of 2026.
Third, downstream effects from the Iran war may begin to affect pricing data. In past Talking Points, we discussed how oil prices can work their way into household items through a variety of channels. Brent crude is up by about 30%, and European LNG is up around 70% since the Iran war started.
We may now also be seeing a deterioration in refining capacity due to the realities of war. Crack spreads— the price difference between crude oil inputs and refined products, such as gasoline and diesel—have widened dramatically in recent trading days. Barring an exogenous demand shock, which seems unlikely, the widening likely reflects constraints in refining capacity that are limiting downstream supply and pushing refined-product prices higher. This impulse may also start showing up in inflation data in the near future.
As things stand, the economy and Treasury Department are still humming along, but clear pressure points are building. Inflation remains in check, and the Federal Open Market Committee is still assessing whether prices are on a sustainable path toward target. According to the latest FOMC meeting minutes, “Most participants [voters] anticipated that inflation would step down over the rest of the year as the effects of tariffs and earlier energy price increases wane, but many participants noted the possibility that inflation might be more persistently elevated.”
The bond market, however, remains less convinced that things will end well. “The surprise buybacks announcement this week has had only a fleeting effect, and we think any deficit-related announcement would be at least as limited,” explained Bianchi of Evercore ISI. Howard Du, a strategist at TD Securities, added: “The market is not fully buying the narrative that Bessent can credibly keep long-end yields in check.”
Additional structural headwinds remain, including the Boomer generation’s shift from saving to retirement spending, Warsh’s apparent reluctance to rely heavily on balance sheet tools, and still uncertain productivity gains from artificial intelligence. Time will tell whether both the FOMC and Treasury can thread the needles of growth, inflation, and short- versus long-term interest rates. For now, interest rates appear to be bleeding higher, despite the Band-Aid.
FROM THE DESK
Agency CMBS — The post-Bessent announcement rally created a brief, yet useful rate-locking window before the broader market faded the buyback headline. Lument used that window to remain active in GNPL and CLC new issuance. Execution opportunities still exist, but they are likely to be short-lived when long-end Treasury pressure remains unresolved.
Municipals — AAA tax-exempt yields moved modestly higher this week, though municipal market technicals remained constructive: Strong investor demand, positive fund flows, and seasonal reinvestment cash continued to offset elevated new-issue supply. Municipal bond funds attracted approximately $838 million in inflows during the week, including $208 million into high-yield funds (the third consecutive week of inflows into the high-yield sector). Despite another heavy-issuance calendar, demand remained sufficient to absorb new supply with limited pricing disruption. Looking ahead, continued elevated issuance could place upward pressure on yields if fund flows moderate and the market moves beyond the peak summer reinvestment period—thereby reducing one of the key technical supports that benefited municipal bonds throughout much of 2026.
The information contained herein, including any expression of opinion, has been obtained from, or is based upon, resources believed to be reliable, but is not guaranteed as to accuracy or completeness. This is not intended to be an offer to buy or sell or a solicitation of an offer to buy or sell securities, if any referred to herein. Lument Securities, LLC may from time to time have a position in one or more of any securities mentioned herein. Lument Securities, LLC or one of its affiliates may from time to time perform investment banking or other business for any company mentioned.
