Bessent and the Bonds

Another short, wonky post. Too much going on for more.

“Speak softly and carry a big stick.” Teddy Roosevelt’s favorite aphorism made sense then and now. Policymakers should avoid being boastful or belligerent, not simply as a matter of good manners, but to save their credibility for moments when it’s really needed.

Obviously nobody expects Donald Trump to follow TR’s advice. No matter what the circumstances, Trump will always insist that he’s carrying a big stick, the biggest stick, a stick like nobody has ever carried before. But I expected a bit more circumspection from Scott Bessent, the Treasury secretary.

After all, a young Bessent was working for George Soros in 1992 when Soros famously engineered a speculative run on the British pound. At the time British officials loudly and repeatedly proclaimed that they would never, ever allow the pound to be devalued — then caved in the face of market pressure, a humiliation from which Norman Lamont, the Chancellor of the Exchequer, equivalent to the U.S. Treasury secretary, never recovered. So Bessent should know the risks of talking big when you might not have the means to deliver.

Oh well. On Tuesday, Bessent — who has been deploying U.S. funds to support the Japanese yen, declared himself in control of the situation: “I am the house now … And you can bet against me if you want.”

So far markets haven’t challenged Bessent’s boasts about the yen. They have, however, tested his attempts to push down U.S. interest rates — and as the headline at the top of this post says, those efforts are failing with flying colors.

Now, I’d like to blame the Trump administration for rising interest rates. The truth, however, is that rates are rising everywhere. As the European think tank Bruegel says,

[The] problem with explanations centred on a breakdown in US institutions is that the rise in long-term rates is not uniquely American. US, German, French, Italian, United Kingdom and Japanese 30-year yields rose by 45-79 basis points in the six months to 28 August, with the US in the middle at 58bp.

Given the craziness of our leadership, America arguably deserves to be punished by the bond market, but the truth is that we can’t see that happening in the data (yet?).

So what is driving interest rates higher? It may not have much to do with policy at all. The simplest story consistent with the facts is that we’re seeing a surge in demand for funds as a result of the AI boom. We are in the midst of a surge in spending on information technology (information processing equipment and software) that is on track to be even bigger than the boom of the late 1990s:

And it’s worth noting that long-term interest rates were even higher then than they are now, even though inflation was low and we had a budget surplus:

As I said, although the Trump administration deserves blame for many things, I don’t think it’s responsible for high long-term rates, any more than Bill Clinton was responsible for high rates in the late 1990s. This looks like the natural market response to the rush to invest in AI.

It is, however, foolish of Bessent to imagine that he can beat rising rates back by talking big while waving his tiny, tiny stick. All he’s doing is further draining his rapidly diminishing reserves of credibility.