Yesterday we talked about the Treasury's move to support the long-end of the government bond market — providing "greater liquidity" in the 30-year bond market, pushing yields lower.
This is the Treasury taking over a function the Fed performed for the past eighteen years (managing liquidity and the level of bond yields).
This looks like the execution of a new 1951-like Treasury-Fed Accord.
Remember, we talked about this back in early February (here), just after Kevin Warsh was named Fed Chair.
As we discussed in that note, both Bessent (Treasury Secretary) and Warsh (new Fed Chair) worked for, and are very close with, legendary macro investor Stan Druckenmiller.
Druckenmiller is a mentor to both. And few in the world understand global liquidity, sovereign debt supply, and how they affect capital flows, risk premiums and market psychology like Druckenmiller.
Fast forward six months, and his proteges are now managing the world's most important liquidity spigots (one from the fiscal side, one from the monetary side).
On that note, in an FT article back in January, Druckenmiller had used the word "accord" to describe the relationship Warsh and Bessent would have between the Fed and Treasury.
That word "accord" is significant, because it's in reference to the 1951 Treasury-Fed Accord that established the Fed as an independent central bank.
During World War Two, the Federal Reserve pegged yields on the government bond market. Bills were at three-eighths of one percent. Long bonds at two and a half. The Fed committed to buying whatever quantity was necessary to hold those levels, with newly created money, without limit.
It worked. It financed the war at cheap rates. But when the war ended the peg stayed, and by 1951 inflation was running hot and the Fed was still legally obliged to buy Treasury debt at prices the Treasury wanted.
The 1951 Treasury-Fed Accord ended it.
The Fed was freed from financing the government. It became an independent central bank. And managing the government bond market went back where it belonged, to the Treasury, through the supply of debt.
That arrangement held for roughly fifty-seven years.
It ended with the Global Financial Crisis.
The Fed became the largest buyer of Treasury debt in the world in response to the financial crisis. Through three rounds of quantitative easing, then a fourth in the pandemic, the central bank bought government bonds to hold long-term rates down.
The Fed financed the deficits. The deficits kept growing.
What the 1951 Accord was designed to separate was again entangled.
As we discussed back in February, it appeared that Warsh and Bessent were assembled to take them apart again.
End the Fed's QE business. Stop the distortion. Give the responsibility back to the fiscal side.
Then yesterday, we saw what may be the execution of that arrangement — the Treasury stepped in to manage liquidity in the long end, taking back the job of managing the bond market through supply.
Is the 1951 Accord restored?
The dollar fell on the news. But that's the opposite reaction of this policy move.
A central bank that monetizes deficits debases its currency. If the Fed is genuinely out of the deficit-financing business, and the Treasury has to manage the debt on its own balance sheet with real constraints, then the structural change toward fiscal discipline should shore up credibility in the dollar.
This should be dollar-positive.
As we discussed back in February, if the U.S. chooses structural reform, those who don't will get punished.
Which brings us to Europe.
The European Central Bank is running the opposite policy.
Its bond market is being held together by the credibility of ECB intervention, and by an instrument built in 2022 that has never actually been used.
This is policy divergence.
One central bank is withdrawing from managing its bond market, and its Treasury is picking up the job openly, with published operations and stated sizes. The other is holding its bond market together with the threat of intervention.
One is separating the fiscal and monetary functions. The other is fusing them tighter.
The currency market should figure it out.
