JPMorgan Chase Analysis: Why isn't the market buying into Bessant's increased U.S. Treasury repurchase program?

Original title: JPMorgan criticizes Bessent's bond market intervention: Markets will perceive the Treasury as "lacking credibility"
Original author: Tyler Durden
Compiled by: Peggy

Editor's Note: On August 19, the U.S. Treasury Department unexpectedly announced that it would raise the cap on single liquidity support repurchase agreements for 10-20 year and 20-30 year nominal Treasury bonds from $2 billion to at least $4 billion, with the new arrangement taking effect on September 9. Following the announcement, long-term U.S. Treasury yields fell by about 9 basis points, and the yield curve flattened significantly.

But the market quickly resumed its sell-off. The following day, the 10-year Treasury yield rose to 4.71%, and the 30-year yield also approached its previous high. This prompted the market to question: if the repurchase program was relatively limited and had not yet been implemented, why did the Treasury choose to adjust its plan only two weeks after the quarterly refinancing announcement?

ZeroHedge, citing a report by JPMorgan Chase interest rate strategist Jay Barry, suggests that the Treasury Department may not be addressing market liquidity failures, but rather expressing unease about rising long-term yields. JPMorgan's real concern isn't the $4 billion buyback itself, but whether the Treasury is deviating from "conventional and predictable" debt management principles and shifting towards more opportunistic maturity and issuance management.

This distinction is relevant to the long-term pricing of US Treasury bonds. If investors believe that the Treasury is attempting to lower financing costs through repurchase agreements or reducing the supply of long-term bonds without simultaneously improving the fiscal deficit, the decline in short-term yields may not be sustainable. Instead, it could increase long-term borrowing costs by pushing up the term premium.

The following is a translation of the original text:

The market initially reacted positively after the U.S. Treasury expanded its buyback program for long-term Treasury bonds.

The Ministry of Finance announced that it will increase the maximum amount of a single liquidity support repurchase agreement for 10-20 year and 20-30 year nominal Treasury bonds from $2 billion to at least $4 billion. According to the Ministry of Finance announcement, the new amount will take effect on September 9th, rather than immediately starting to buy bonds on the day of the announcement.

Following the announcement, long-term US Treasury yields fell by about 9 basis points, and the yield curve flattened by a similar amount. However, this rally did not last long. The following day, the 10-year US Treasury yield rose to 4.71%, essentially reversing the decline following the announcement.

JPMorgan Chase believes that the most noteworthy aspect of this repurchase adjustment is not its scale, but its timing: the Treasury Department just released a provisional repurchase schedule for the next three months in its quarterly refinancing announcement on August 5, at which time the single repurchase limit for 10-20 year and 20-30 year Treasury bonds was still $2 billion.

Why did the Ministry of Finance suddenly increase stimulus measures when there was no obvious market failure?

US Treasury repurchase agreements are mainly divided into two categories: cash management repurchase agreements and liquidity support repurchase agreements.

This adjustment targets the latter. The Ministry of Finance improves trading efficiency between different bond types and provides market participants with a predictable exit channel by repurchasing relatively illiquid, inactive bonds—that is, treasury bonds that are no longer from the latest issuance batch.

Under this mechanism, the core basis for deciding whether to increase the scale of repurchases should usually be whether market liquidity has deteriorated.

JPMorgan Chase, referencing an assessment framework previously proposed by the Treasury Borrowing Advisory Committee, examined the size of repurchase agreement bids, the dispersion of the Treasury bond curve, and the valuation differences between active and inactive bonds. Their conclusion was that relevant indicators for 10-20 year and 20-30 year Treasury bonds remain close to their average levels over the past year, showing no significant market dysfunction.

The report states that the pricing deviation of inactive bonds relative to the fitted yield curve has remained stable, significantly lower than the extreme levels of the past five years; there has also been no significant misalignment in the asset swap spread between active and inactive bonds. Overall, the performance of the US Treasury market has actually improved this year.

Therefore, JPMorgan Chase interprets this temporary adjustment as a policy signal: the Treasury may not be concerned about liquidity, but rather about long-term yields themselves.

The Ministry of Finance may be developing a new long-term "reaction function".

JPMorgan Chase believes there may be a common thread among the recent series of policy actions – the Treasury is showing greater sensitivity to rising long-term yields.

This involves a commonly used market concept: the reaction function, or "policy response function." It's not a formal rule, but rather an indicator used by investors to predict what measures policymakers might take under what conditions, based on their past statements and actions.

According to JPMorgan Chase, the Treasury's decision to announce repurchase adjustments hours before the 20-year Treasury bond auction and the day before the 30-year inflation-protected Treasury bond auction may indicate its desire to alleviate long-term financing pressures. However, this is still an analyst's interpretation of policy intentions, not a confirmed policy objective from the Treasury.

The report also points out that the rise in US Treasury yields this year can largely be explained by the market's hawkish repricing of the Federal Reserve's policy path. According to JPMorgan Chase's fair value model, the 10-year yield has not significantly deviated from fundamentals.

The real deviation occurs over longer periods. Global long-term bond yields have generally risen, especially Japanese long-term government bond yields, which has reduced the relative attractiveness of US Treasuries to some overseas investors.

During Japan's implementation of negative interest rate policies and yield curve control, the yields of US Treasury bonds, hedged against currency fluctuations, were more attractive than Japanese government bonds, helping to suppress long-term US interest rates. This mechanism is now partially reversing: rising long-term Japanese interest rates may reduce the incentive for Japanese funds to allocate to US Treasuries and amplify upward pressure on the long end of the US yield curve.

Buybacks are a temporary fix, not a permanent solution; the deficit is the core issue behind the term premium.

JPMorgan Chase's main criticism of the Treasury's strategy is that while buybacks can alleviate short-term pressure in the long-term bond market, they cannot change the fiscal backdrop of continuously increasing supply of US Treasury bonds.

The report projects that the U.S. funding gap could exceed $3.5 trillion over the next few fiscal years. In this environment, the Treasury may ultimately need to provide more, not less, maturity to the market. Even if the Treasury reduces the size of its long-term debt auctions, it will only shift funding needs to other maturities and will not eliminate overall borrowing demand.

JPMorgan Chase also pointed out that there has been no collapse in demand at long-term bond auctions so far. End-investor participation in 30-year Treasury bonds is at a record high this year, and demand for 20-year Treasury bonds is also near historical highs. This further weakens the explanation that "temporary increases in repurchase agreements are necessary to improve market functioning."

The underlying issue remains the fiscal deficit. JPMorgan Chase describes the current fiscal situation as a deficit of about 6% of GDP; the Congressional Budget Office's baseline forecast in February is a deficit of $1.9 trillion in fiscal year 2026, about 5.8% of GDP, which is roughly the same as the previous estimate.

The report argues that without substantial fiscal consolidation, markets may perceive more flexible and opportunistic debt management as lacking credibility. If the Treasury deviates further from the principle of "regular and predictable" issuance, investors may demand higher term premiums to compensate for future supply, inflation, and policy uncertainties.

This means that an operation aimed at lowering long-term interest rates may actually risk pushing up yields in the long run. However, this is still a risk scenario proposed by JPMorgan Chase, not a result that has already occurred.

British experience: Adjustments to long-term debt supply often have diminishing returns in impact.

To determine whether reducing the supply of long-term bonds can sustainably suppress yields, JPMorgan Chase cited the experience of the UK.

The UK has lowered its forecast for the ratio of long-term government bonds to net issuance to 9.1%, from 28.4% in April 2022. The UK Debt Management Authority has lowered this ratio 12 times in the past four years.

These adjustments typically flatten the yield curve in the short term. JPMorgan Chase estimates that within five days of the announcement, the spread between the yields on 5-year and 30-year UK government bonds narrowed by an average of about 2 basis points; if we observe the ten-day window before and after the announcement, it narrowed by an average of about 5 basis points.

However, this effect was not lasting, and as similar actions were repeated, the boosting effect of each announcement on long-term government bonds gradually weakened. Although the UK benchmark interest rate has fallen by 175 basis points from its recent high, long-term UK bond yields remain near multi-decade highs.

JPMorgan Chase believes that while increased U.S. repurchase operations or reduced long-term bond issuance may lower long-term yields in the short term, they are unlikely to change the long-term trend. Unless the fiscal deficit narrows simultaneously, supply-side structural adjustments are unlikely to become a tool for stabilizing and lowering financing costs.

Going forward, the market needs to observe not only whether the Ministry of Finance continues to increase the scale of repurchase operations, but also whether it reduces the scale of 20-year and 30-year Treasury bond auctions, and whether there are substantial changes in the fiscal deficit, overseas demand, and term premium.

If long-term yields continue to rise after the repurchase agreements are actually implemented, or if the rallies following each policy adjustment become increasingly shorter, it will support JPMorgan Chase's assessment that "debt management cannot replace fiscal consolidation." Conversely, if market liquidity indicators deteriorate significantly, and repurchase agreements continue to improve trading efficiency, then this adjustment is more likely to prove to be a technical maneuver rather than an attempt by the Treasury to directly control long-term interest rates.