Severe Criticism from the Senate of the U.S. Treasury Buyback Policy; An Intervention That Backfired

The expansion of the Treasury buyback program by Janet Yellen, the U.S. Treasury Secretary, has provoked a strong reaction from Congress. Senator Elizabeth Warren harshly criticized it as a "chaotic intervention" and set a deadline for clarification on whether the Treasury is using public resources to manipulate long-term interest rates.

With the yield on long-term U.S. Treasury bonds rising to its highest level in over two decades, Yellen's action to expand the buyback program has faced a new wave of congressional questioning.

Senator Elizabeth Warren, a senior Democrat on the Senate Banking Committee, sent a letter to Yellen on Wednesday demanding that the Treasury explain a series of recent actions targeting the U.S. Treasury bond market. She described this operation as an "unprecedented and chaotic intervention" and asked whether the Treasury intends to finance further expansion of long-term bond buybacks by drawing from the cash balance of the "Treasury General Account" (TGA).

Warren also requested clarification on whether the Treasury is considering other measures to reduce long-term bond yields in addition to the buyback program, and how much the increase in long-term rates has impacted household borrowing costs such as mortgage and auto loans. She requested that the Treasury provide its response by October 21.

Treasury Suddenly Expands Buybacks, Yet Yields Continue to Rise

This controversy stems from the Treasury's surprising announcement on August 19 regarding the expansion of the long-term Treasury bond buyback program.

This decision was made just two weeks after the Treasury released its quarterly financing program. The U.S. Treasury has long emphasized that debt management should adhere to the principle of "orderly and predictable"; therefore, the sudden adjustment of the buyback policy outside the quarterly financing window caught some Wall Street institutions off guard.

As a result, the Treasury raised the buyback cap for specific 10- to 30-year bonds from $2 billion to $6 billion per operation. Yellen stated that the expansion of buybacks was primarily aimed at improving the liquidity of older securities (off-the-run) so that banks and other institutions could sell older, less tradable debt and enhance their capacity to participate in new debt auctions.

However, Yellen's public statements have also led the market to believe that the Treasury hopes to simultaneously slow the rapid rise in long-term bond yields.

She had previously described market movements as creating a "fever" and referred to the expansion of the long-term Treasury bond buyback as a kind of "Treasury version of Operation Twist." When extensive buybacks of long-term bonds were first implemented in September, the Treasury increased the maximum purchase volume to $6 billion, three times the previously planned amount.

As a result of this action, long-term bond yields did not continue their downward trend. The yield on the 10-year U.S. Treasury bond rose again this week to its highest level since 2002, while the yield on the 30-year bond approached 5.7%, the highest level in over two decades.

Warren stated in her letter that the increase in U.S. Treasury bond yields is primarily a result of the government's own policies and questioned the Treasury's efforts to reduce long-term financing costs through debt management operations.

Actual Treasury Purchases Are Below Set Caps

A contradiction has also emerged within the buyback program itself: although the Treasury significantly increased the amount available for purchase, it has not utilized all of this quota in practice.

Reuters previously reported that in recent buybacks of long-term Treasury bonds, the agency accepted only about half of the bonds offered by investors, and each actual purchase was below the announced maximum cap, with purchases concentrated in only a few securities.

This has led some investors to doubt the true objective of the Treasury's expansion program.

If the main goal is to improve market liquidity, then the Treasury does not need to accept offers at excessively high prices to reach the set ceiling. Padhraic Garvey, head of North America research at ING, believes that the Treasury can effectively reject unattractive sell orders, and from this perspective, the program continues to operate according to its original goal.

Some market indicators also show that the liquidity of older bonds has improved. The price difference or spread between long-term Treasury bonds and SOFR-related swaps has decreased, which some analysts see as a sign of the program's effectiveness.

However, if the market interprets this policy as the Treasury attempting to reduce the yields on long-term bonds, the results have not been ideal so far. Since the expansion of the buyback program on August 19, the yields on 10-year and 30-year Treasury bonds have continued their upward trend.

Thomas Simons, a senior economist at Jefferies, believes that part of the problem stems from the timing of the announcement of this policy. The Treasury did not wait for the regular quarterly financing session but abruptly changed its plans during a major selling period in the market, which led investors to easily associate buybacks with yield control.

Funding Source for Buybacks Becomes a New Controversy

Another key question is how the Treasury will finance the extensive buyback program.

Initially, the market widely assumed that the Treasury would increase the issuance of short-term securities and use the proceeds to buy back long-term bonds. In practice, this is equivalent to reducing some long-term debt and increasing short-term financing.

However, another possibility is direct withdrawals from the Treasury General Account (TGA) cash balance.

Warren specifically asked Basant to clarify whether the Treasury is prepared to continuously reduce the TGA account balance to expand long-term bond buybacks. If this approach is adopted, the Treasury could purchase more long-term bonds without immediately increasing short-term debt issuance, but the government's cash buffer would also shrink accordingly.

The Treasury has not yet specified whether it is ready to continue drawing from the cash account.

The buybacks themselves also involve cost compromises. Many of the older bonds that the Treasury is currently purchasing were issued during the pandemic in an environment of low interest rates and low yields. Since the current market yields are significantly higher than the interest rates of these bonds, they are trading well below their face value.

From a debt management perspective, the Treasury can buy back these older bonds at a discount; however, if funding is obtained through the issuance of new short-term securities, the new debt will carry a much higher interest rate than the interest rates of the older bonds, so future interest costs for the government will not necessarily decrease as a result.

Meanwhile, Basant has consistently attributed the rise in long-term bond yields to broader macro factors, including Middle Eastern wars that have driven up energy prices and inflation, as well as investor concerns about the U.S. budget deficit. He believes that with the end of the conflict with Iran, a decrease in energy prices, along with economic growth and fiscal stabilization, government financing costs will ultimately decrease.

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