As we near the end of August, all eyes are centered on Jackson Hole, Wyoming. The well-heeled mountain town is slated to host its 49th annual economic policy symposium with the Chairman of the Federal Reserve Kevin Warsh delivering a closely watched speech on Friday. Amid a more interventionist Treasury, ongoing conflict in the Middle East, and concerns about inflation, Warsh needs to clarify the Fed’s reaction function, both on rates and balance sheet policy, without appearing too supportive of U.S. Treasury Secretary Scott Bessent’s recent actions.

Markets are testing the Treasury’s credibility and appetite for intervention. The signaling effect of last week’s buyback announcement has already faded, with 10- and 30-year Treasury yields back near pre-intervention levels. That’s a clear sign the Administration cannot jawbone global bondholders the way it can pressure the Fed. These investors price risk for a living. Short of implementing Bank of Japan-style yield controls, the campaign to put downward pressure on long-term borrowing costs by talking about a “big toolkit” is unlikely to succeed.

Also caught in the crossfire has been the U.S. dollar, which depreciated after the announcement and has recovered only partially. Investors are talking again about the “debasement trade,” with both gold and bitcoin rising sharply. Those moves reflect what sophisticated investors actually believe about the sustainability of the U.S. fiscal position.

During his last press conference, Fed Chairman Kevin Warsh explained that one reason for limiting forward guidance is a desire to hear what markets have to say unfiltered. But a more interventionist Treasury trying to set prices in bond markets means he will instead confront what Treasury is saying, not what investors actually think.

Against a backdrop of threats to Fed independence, the prospect of fiscal dominance, where the Treasury may try to use the Fed’s balance sheet to lower interest rates, is not reassuring. Increased unpredictability of Treasury issuance and rising risks of fiscal repression may push long-term inflation expectations and term premiums higher, as global investors require greater compensation to bear the risk of holding longer-term bonds. That would effectively undo Secretary Bessent’s effort to lower borrowing costs for households and firms.

How we got here

Bessent’s interventionist tilt started with buying yen in late July and has since escalated with the intention to double Treasury’s buyback of longer-dated debt. It signals unease about rising long-term Treasury yields at a time when U.S. national debt has surpassed $40 trillion for the first time, with the debt held by the public around $32 trillion.

While Treasury has framed buybacks in term of market liquidity, there is little evidence of stress in Treasury cash and funding markets. Rising long-term yields instead reflect a deteriorating fiscal outlook, concerns about stubborn inflation, heightened geopolitical tensions, and a lack of clarity from Chairman Warsh about how the Fed intends to restore inflation to the 2% target. Counter to Bessent’s best efforts, Treasury can’t fight fundamentals with temporary intervention. Lowering yields requires structural fiscal reform, and better communication from the Fed about their anti-inflation strategy.

What this means for monetary policy

The mechanics of the buybacks matter here. According to CNBC, the Treasury could finance the purchase of long-term Treasury bonds by drawing down the Treasury General Account (TGA) at the Fed—which currently stands at more than $950 billion. A large enough TGA drawdown would function much like a sizable round of Fed quantitative easing. For example, the Fed buying $500 billion of long-term Treasuries funded by new reserves is analytically almost identical to Treasury buying $500 billion by drawing down the TGA. Both put reserves into the banking system. Depending on the scale, this could ease financial conditions that are already quite loose, with equities near record highs and credit spreads tight.

How will the Fed react? The Fed could scale back “reserve management purchases,” purchases of Treasury bills and other Treasury securities with remaining maturities of three years or less used to maintain an ample level of reserves. That would effectively offset some of the yield-lowering effects of the Treasury’s actions.

That said, it may not sit well with a Fed facing inflation still well above 2%, with risks skewed to the upside given Middle East tensions and a brewing U.S.-Canada trade war. If a significant volume of reserves flowed back into the system, the fed funds rate could slide toward the bottom of its target range, complicating the Fed’s control of rates and its communication.

Investors now assign about 40% odds to a policy tightening at the September Federal Open Market Committee (FOMC) meeting. Three officials dissented at the July meeting, and minutes suggest several already favored a 25-basis-point increase. An easing of financial conditions from Treasury’s side may end up forcing the Fed into a tighter stance than it would otherwise choose.

On balance sheet policy, Warsh has previously suggested the Fed could ease monetary policy while offsetting it by shrinking the balance sheet and reducing the duration of Treasuries in its System Open Market Account (SOMA) portfolio, effectively steepening the yield curve. Treasury’s own efforts to shorten average maturity, issuing more T-bills and funding buybacks through the TGA, could work against that.

The meeting of central bankers in Jackson Hole, Wyoming, this week provides an opportunity for Chairman Warsh to reaffirm his credibility with investors. He gives the keynote address to the conference Friday at 10 a.m. EDT. He can stand by his stated independence from the executive branch or begin a slow slide toward the world preceding the Treasury-Fed accord of 1951 which separated government debt management from monetary policy.

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