Today we get the S&P PMI for both manufacturing and services

Outlook

Today we get the S&P PMI for both manufacturing and services. Markets prefer the other version but expectations are for improvements. In addition, Bloomberg reports some economists are raising the GDP forecasts.

But institutional Events trump economics every time. Anatomy of a policy failure: see the 5-day chart of the 10-year yield from Trading Economics. Back on Aug 18, the yield was 4.704%. Then it soared to 4.745% on 8/18, whereupon Bessent announced intervention. The yield fell to a low of 4.643% on Aug 19. But yesterday it went back to a high of 4.7139, which is higher than it was before the crisis.

There is no way to consider the intervention announcement as anything other than a total failure. Krugman is not the only analyst pouring scorn on Bessent for being a sycophant and violating the free market principles he exploited to become a millionaire in the first place.

Markets are still trying to grasp what the Bessent Affair means and what will happen next. Was he just trying to smash a panic—a short-term, one-time act? Critics pointed out the size of the intervention is tiny, to which Bessent responded by saying it could get doubled or more. Or was he just referring to the doubling of the already planned buybacks? That doesn’t help the short-term/long-term question. The plan is to spend up to $4 billion at several points between Sept. 9 and Nov. 4, the day after Election Day. Again, no help.

By now everyone is acknowledging that buybacks of any size are not going to fix the underlying reasons for the yields to have soared in the first place—chiefly too much debt, a government that is hell-bent on over-spending, and war-induced inflation. Intervention cannot help the price of oil. Everyone also sees the Treasury on a collision course with the Fed.

Now that the symbolic intervention failed to hold, we must expect additional efforts. Bessent cannot be seen to have failed, not only for his own ego but the reputation of the US Treasury and country at large. He could even be fired by Trump. The first round of promising to double the buy-backs didn’t work. Maybe the second one will, and if not the third one and even that “fiscal consolidation.”

A key question: the first market interference announcement would affect only a tiny fraction of the overall longer-term markets. It’s symbolic rather than determinative. It got a Bronx cheer from the market. Now that it has failed, it doesn’t matter whether the it was just an emergency act to control panic (or a trick to help the stock market). Now it’s a battle of wills between the Treasury and the market.

This is a savvy, quick-thinking bunch of folks. Bessent will have to dance perfectly, in time with the music and gracefully. He is not a natural born bully like his boss but he is really smart and has tremendous resources. We don’t want to bet against him. At the same time, the consensus was almost immediate that he can’t achieve any lasting drop in yields given the massive underlying reasons for yields to rise.

Bloomberg notes that given the debt ceiling, at some point Bessent will run out of ammunition. A Rabobank economist says “If the Treasury runs out of firepower and yields spike again, the Fed may feel compelled to step in and buy these bonds. This scenario could render Kevin Warsh’s internal debate about balance sheet reduction entirely academic. Instead of exiting the fiscal space, the central bank would be pulled even deeper into it.”

The effort to send a smoke signal to the bond gang ended up in a return barrage of hard bullets. The market wants real action, not symbolic gestures. Goldman says credible action on inflation would do the trick. Others point out the Fed can just raise rates, which is also a smoke signal but one with greater muscle. This means Warsh’s remarks at Jackson Hole next week are going to be more important than ever.

Forecast

The Bessent intervention is not working but at the same time, the market is somewhat fearful. We would be surprised to see another frightening rise. It doesn’t mean the market won’t raise yields even higher, just that it won’t do it in giant moves. Slowly, slowly catchy monkey. The old phrase is “don’t fight the Fed.” We are going to get a new one—“don’t fight the bond market.” 

Longer run, everyone knows the buy-back adds to liquidity/money supply and promotes inflation, if not in the short-term. It also runs entirely counter to Mr. Warsh’s plans for the Fed balance sheet, which would contract money supply and serve as substitute for a rate hike. We have a few weeks before the next Fed meeting (Sept 19) to get this into perspective.

In the end, we suspect the Treasury buy-back will be seen as inconsequential. Either Bessent retreats and gives up or tries some other initiative that keeps markets on the backfoot for a while. A series of short-terms is a long-term. If Bessent’s goal is to keep yields down until the midterms, he may well get away with it. That is what will be noise but hey, it may well work.

Meanwhile, the inflation and jobs data coming due before the Fed meeting are expected to be tame, so a push to falling yields, not rising ones. Traders still dislike market interventions, but if conditions quiet down, the issue will become background and the dollar drop will likely persist.

This doesn’t mean trust in the US has not fallen. Reserve diversification will continue. 

Then there is the issue of the Iran war. Iran has been able to evade sanctions through piracy and black markets for some 40 years. The economic consequences that Trump promises are very hard to deliver, but not impossible. It all depends on the value of the US intelligence, since we know Trump will act immediately once he has a target. We have not seen any information about which countries aiding Iran under the table are going to be targeted. As noted before, this could work, but it takes brains and capability, and it’s not clear that Trump’s unqualified lackeys have not diminished the US’ ability to take meaningful action.

The “economic consequences” to come are a deferral of the resumption of the shooting war. Presumably Trump wants to put it off until after the mid-terms (although we still worry about his vanity and impatience). Meanwhile, Iran is allowing some ships to get through the Strait. The number of ships and barrels of oil per day is in doubt, as reported yesterday, but it’s not zero. Is Iran keeping its powder dry or is it not militarily able to bomb those dark tankers?

The expected steadier and slightly falling yields are dollar-negative. The absence of outright shooting/bombing in the Iran war, while only a stop-gap, is also dollar negative. Added all up, we get the case for the currencies to thrive and the dollar drop to continue. But something can still hit the fan (like a lousy “fiscal consolidation” on Monday that gets laughed out of the room).

Food for thought

The US has been getting away with over-indebtedness for many years. It has yet to generate an actual crisis. Former NY Fed chief Dudley wrote in Bloomberg that yes, this time is different.

And he’s talking about the stock market, which will make everyone sit up and take notice. Here is the AI summary:

“The US equity market is in bubble territory, with metrics such as the Shiller cyclically adjusted price-to-earnings ratio, the real equity risk premium, and the Buffett Indicator pointing to overvaluation.

“The bubble will likely burst before the end of 2027 due to factors such as the diminishing impact of the artificial intelligence investment boom, slowing investment spending, and increasing supply of US equities.

“The macroeconomic environment is likely to become more challenging, with rising long-term rates and a lack of progress to address the nation's unsustainable federal debt trajectory, which will weigh on equity market valuations.”