THE US Treasury might like to talk tough. Secretary Scott Bessent’s latest salvo was directed at foreign-exchange traders. He warned them against betting against the US dollar.
“I am the house now… you can bet against me if you want,” he told them. He was referring specifically to the US Treasury’s support for the yen.
Bessent might just be able to pull off his audacious support for the Japanese currency, but only if the Bank of Japan plays ball by raising interest rates.
Fooling around with currencies is one thing, but playing fast and loose with the bond market, especially with US Treasuries, is another.
He actually believes that he can suppress long-term interest rates by buying back US$6 billion worth of 30-year Treasuries. By pushing up the bonds’ prices, he hopes to force down the yield on them.
Worryingly, Bessent is missing the point about why the market is selling Treasuries. It has nothing to do with betting against the “house”.
Pension funds, sovereign wealth funds, insurance companies and family offices are not gamblers. They are selling Treasuries because they believe that the Federal Reserve is not doing its job properly. They also think that America is being reckless with its finances.
Who holds the cards?
Bond investors were always going to decide where US interest rates should be. They weigh up many factors before they decide whether to lend money to the US government.
The Trump administration might think that it can influence and cajole the Fed. But the reality is that the Fed, and even the US Treasury, is powerless against bondholders.
It would be different if America does not have to borrow money – but it does.
Its national debt is US$40 trillion dollars and rising. Annual payments on these loans exceed US$1 trillion and are going up, too. That is why bond investors are worried.
To borrow a phrase from US President Donald Trump, America does not have the cards. Lenders will always have the upper hand.
Meanwhile, the Treasury secretary might also like to think that he can manipulate interest rates by selling short-duration debt and buying 30-year Treasuries.
But bondholders will not be fooled that easily. For every dollar of long-dated Treasuries that Scott Bessent should buy, bondholders can sell much more.
Pragmatism reigns
Bondholders are essentially pragmatic investors. They just want the Fed to do the right thing, which is to tame inflation. There is only one tool that it has in its armoury to do that effectively, which is to raise interest rates.
It is quite unacceptable that the US inflation rate has been allowed to stay above the Fed’s target for more than five years. And of those five years, two have been under a Trump administration.
Currently, there are few signs that the inflation rate will return to 2 per cent, given that global supply chains have been fractured by Trump.
The Iran war, which was started by the president, has exacerbated inflationary pressures by pushing up energy prices. Brent crude is trading above US$100 a barrel. If we throw in climate change, which Trump claims is a hoax, then we could see persistently higher food prices too.
The outlook for inflation does not look good if things should stay as they are. It could worsen unless central banks act decisively.
This is not just a US problem. Many economies also face similar issues. Furthermore, many countries are probably reaching the limit that they can comfortably borrow.
Shock and awe
It will not be pleasant for stock market investors if bondholders continue to flex their muscles. We are closing in on a tipping point for shares. The 10-year Treasury yield is fast approaching 5 per cent.
Meanwhile, the US market is valued at 25 times earnings, which implies an earnings yield of 4 per cent. Even Singapore’s Straits Times Index (SGX: ^STI) is valued at 20 times earnings, which suggests an earnings yield of 5 per cent.
When investors have a choice between a risk-free asset that offers a yield close to 5 per cent and a risk asset with a more unpredictable future, then they could have a reason to think twice. Whether the Fed raises interest rates becomes a moot point.
But this could be just the time for investors to look at businesses with dependable cash flow, high returns on equity and a strong track record of rewarding investors with regular dividends.
As an income investor, any correction in share prices that might ensue could be an opportunity to buy more rising income from good companies.
Investing is never about trying to second-guess where share prices might be tomorrow or what the Fed might do at its next meeting. It is about working out the yield on an asset over its lifetime.
In other words, it is about buying wonderful companies at fair prices and holding them for the long term.
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