Can Bessent Beat the Markets as Inflation Invites Fed Rate Hikes?

Oil jumped as the US and Iran traded fire yet rate hike bets stood pat, while an epic bond auction signaled markets are buying the “yield suppression” that Treasury Secretary Bessent is selling. All eyes now turn to inflation data.

• The “war trade” logic linking oil prices to inflation expectations and Fed rate hike speculation seems broken
• A blockbuster 10-year note auction says markets believe Treasury Secretary Scott Bessent can keep long-term yields in check, at least for now
• US inflation data and a 30-year bond sale are now in focus. The outcomes may amplify the “yield suppression” trade, boosting gold and hurting the dollar

Surging energy prices might have been expected to stoke rate hike speculation, boosting the odds that the Federal Reserve will act as soon as this month. They did not. Meanwhile, a stellar 10-year Treasury bond auction signaled Treasury Secretary Scott Bessent is winning his fight to keep long term borrowing costs in check, at least for now.

Crude oil prices raced higher for a second day, with the WTI benchmark hitting the highest level since May. The move comes amid escalation in the US-Iran war, where tit-for-tat attacks have targeted Iranian oil tankers and US military assets across the Middle East, while Washington has imposed a fresh round of sanctions.

In the logic of the “war trade” established at the start of the conflict, rising oil prices translated into inflation fears, which markets took to mean that the Fed must press ahead with rate hikes. Traders decided that a hawkish speech from Chair Kevin Warsh at last month’s Jackson Hole symposium amounted to a plan to do just that.

The “war trade” has turned into the “yield suppression trade”

Oil’s latest heroics made no such impression. Fed funds futures put the priced-in probability of at least one rate hike before year-end at a commanding 87%, but that has hardly changed since Warsh roused the hawks two weeks ago. Gold and silver prices rose while the US dollar struggled, as if to reiterate the point.

Inflation expectations have indeed moved higher, but oil no longer seems to be the culprit. Breakeven inflation rates priced into five- and ten-year Treasury bonds now sit at three-month highs, but they were plodding along at their lows of the year when oil began to rally again in July. They wouldn’t come alive in earnest until mid-August.

Tellingly, that was when Secretary Bessent made explicit that Treasury intended to weigh in against the steep rise in bond yields since the Iran war began. He loudly proclaimed that the size of the department’s bond buyback operations of stale long-term securities would rise from $2 to at least $4 billion.

Since then, the long end of the Treasury yield curve has flattened sharply. The spread between ten- and 30-year rates narrowed by 13bps even as hawkish screeching from the Fed chair fueled steepening at the front end, pushing out the two-year to three-month yield spread to the highest since November 2022.

If Bessent runs the markets now, gold has more room to rise

Gold prices rallied while the US dollar fell against that backdrop. Bitcoin’s performance looked especially impressive. Bessent touched off a blistering rally that sent prices up 22.5% that very week. This put them at four-month highs, where they have hovered since. The signaling in that price action looks about as dovish as can be.

Moreover, the markets seem to be buying what the Treasury Secretary is selling. A stellar ten-year Treasury bond auction this week signaled strong demand. Yields jumped to 4.834% – a 19-year high – and traders snapped up the offering. Dealers got just 4.3% of it, the lowest in a year, while direct and indirect bidders took down the rest.

The markets are now operating with a sort of strange duality. On one hand, they are convinced that the Fed must raise interest rates at least once before year-end to check above-target price growth and ensure it is not sticky. On the other, they see the Treasury’s yield suppression efforts as fuel for the so-called “debasement trade”.

A pair of official inflation reports from the Bureau of Labor Statistics (BLS) and a 30-year Treasury bond auction now take center stage. Wholesale inflation (PPI) is expected to register the first uptick since May in August, rising to 5.3% year-on-year, while consumer prices (CPI) rise at a steady clip of 3.4% year-on-year.

If traders shrug at target-busting price growth much as they did last week’s chipper employment and service sector activity data while demand for long-term US debt turns out strong again, the message will ring out loudly. Markets will seem to be saying that Bessent gets to have his way for now, fueling debasement trade dynamics further.

Ilya Spivak, tastylive Head of Global Macro, has over 15 years of experience in trading strategy. He specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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