Why Bessent Tried To Rescue The Bond Market (And Failed)

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1:13Money market's mad. If money is evil, then that building is hell. The show goes on! The folks in there are watching so soon! Welcome to Prof G Markets. I'm Ed Elson. It is September 1st. Let's check in on yesterday's market vitals. The major indices declined as the US and Iran exchanged fire for the first time in a month. Brent crude climbed. The yield on 10-year treasuries rose. And finally, Amazon shares fell nearly 3 % as the FTC sued the company, claiming it overcharged advertisers. Okay, what else is happening? Two men in Washington are pulling the bond markets in opposite directions. At the Federal Reserve's July press conference, Fed Chair Kevin Walsh said that he would keep withholding forward guidance.

2:03The 30-year jumped and kept climbing, eventually passing 5.3%, its highest level in nearly 20 years. Walsh had argued that investors should trade based on the economy rather than the Fed's forecasts. The central bank, he said, is, quote, quote, trying not to interfere with that market signal. But then, a couple weeks ago, Treasury Secretary Scott Besant did exactly that. He announced that the government would, quote, at least double the size of its debt buybacks, raising the cap per operation from$2 billion to more than$4 billion. The goal was to support liquidity and put downward pressure on long-term borrowing costs.

2:39That same day, the Treasury reported that the national debt had crossed$40 trillion for the first time ever. Yields initially fell before climbing back up. So here to join us to discuss the bond markets, to discuss Besson's intervention, and what Federal Reserve Chair Kevin Walsh might think of all of this. We're speaking with our friend Robert Armstrong, U.S. financial commentator for the Financial Times and author of the Unhedged newsletter. Rob, great to see you. Just so you know, we have been off on vacation for two weeks, so we haven't been reading or covering any of this. We leave for two weeks and then suddenly the bond markets have perhaps their most chaotic couple of weeks in recent memory.

3:21Robert Armstrong:I mean, you go away just for a little while and look what happens, you know. So thanks a lot. So we're going to need to back up a little bit and get your summary of what actually happened here from Besson's intervention and then to Kevin Walsh giving what seems to be a little bit more of a hawkish stance in his Jackson Hole speech. What's going on with interest rates? what's going on in the debt markets as well. Let's start with Besson's intervention. I'm struggling to remember the exact date, but what he did was buy bonds, U.S. Treasury bonds, in a somewhat unusual way. There is a normal action that the Treasury takes called buybacks, which is an effort to keep the Treasury market operating smoothly.

4:10Robert Armstrong:And they do this because, as treasuries get older, as they sit in the market longer, they become harder to trade. It's like an old issue with a weird interest rate, and there's not that much of it around. And so on a very regular basis, it's been normal for a couple of years for the treasury to go into the market, buy the old ones, and replace them with new ones. So taking out the stuff that's hard to trade and replacing it with brand new liquid stuff that trades easily. What Besant did that is different is he did it off schedule and then promised to do even more of it off schedule. So what is normally an operation that can be legitimately described as an effort to make the plumbing work better or in kind of finance ease to improve liquidity looked very transparent apparently to everyone in the world, like an effort to prop up the price of bonds by buying them.

5:15Robert Armstrong:There was also some comments that perhaps in the future, the treasury would use the treasury's general account for these kinds of operations, which would be kind of new. The treasury general account is the treasury's checking account. Basically, it's where your tax dollars go and where the spending comes out of. And that was like, whoa, he's going to use the general account. so it was an attempt to to shock the market and get a stronger bid for bonds and it didn't really work and so and the thing about these kind of government actions you can ask the government of japan about this when they don't work they tend to make things worse right like if you are going to take a shot at the bond market you better kill it yes you know what i mean you better yes Yes.

6:06Robert Armstrong:You know? And so then nerves are running high all of a sudden. Yeah. To intervene in the bond market in an unusual way seems to suggest that there is something wrong in the bond market. Is there evidence to believe? I mean, clearly things got worse after he made that intervention, but was there something wrong to begin with? Well, they didn't get way worse, but they did get worse. You could say it didn't have much effect. I mean, what's wrong to begin with is that yields are creeping higher. You know, after, coincidentally or not, after that second late July press conference by Warsh, we saw a move up in yields and yields have stayed high.

6:48And from the point of view of the Treasury Department, the problem with high yields is they make the U.S.

6:55Robert Armstrong:government harder to fund. And the job description of the Secretary of the Treasury, line one, is fund the U.S. government. So this is a problem. And when you have as much debt as the U.S. has, the interest rate on that debt is really important. A couple of points of difference in that interest rate really swings the total deficit. And you can get into a really bad spiral where the deficit gets worse because interest rates are higher. People get more worried about the sustainability of the debt. They push the Treasury yield up higher and you're off to the races. And you don't want to get into that kind of a cycle.

7:37Robert Armstrong:So you can see why the Treasury secretary would be nervous. So right after this happened, Trump was asked about it. He was asked about the fact that Scott Besson had intervened in this way. His response was quite remarkable. I want to play this and get your reaction. Did you direct Secretary Besson to intervene in the bond market? No, not at all. No, he's a very capable man. He wanted to do it. He's very good at it. He has a good touch, very good natural touch for the bonds and interest. And he did that, yeah. The yields have come back up since then. Have you talked to him about another type of intervention?

8:14Is that something he will be doing? We have many types of intervention. And that's one. The ultimate intervention is our military. And if we have to use that, we will. So are we to believe that Trump will start invading nations with military in order to buy U.S. bonds? What are we supposed to make of that comment?

8:30Robert Armstrong:Well, yeah, no, this is what I was thinking. Is this just going to be an aerial campaign, like the campaign in Iran? Are we going to bomb the bond markets or is it going to be a boots on the ground kind of thing? where American lives are at risk, where you have like soldiers in the offices of investment banks exchanging fire with bond traders on the trading floors. Gun to their head, buy the bonds now. I mean, it was an absolutely wild comment and there's no explaining it. But it caused some good laughs around the FD offices. I can tell you that for sure. — Going after that, we had, of course, the Jackson Hole speech.

9:14Kevin Walsh seems to change his tune, and we saw that reflected in the probability of an interest rate hike in September, at least in the prediction markets and also in the CME as well. What did we learn in this speech? What did he tell us, and how does it relate to what we saw with Scott Besson? I would describe the performance of Warsh in his first two press conferences at the Fed as a bit vague.

9:43Robert Armstrong:He said, I don't want to give forward guidance. He used this confusing metaphor of the referee and the ball. Play the ball, not the referee. A metaphor I don't think really applies very neatly to what is going on here. where he said he doesn't want to give forward guidance, but he didn't really give a strong indication of what he would do and how he would kind of make sure that the Fed's position was clear enough in the markets. And I think what is hard about that, I mean, we can have a whole discussion, the kind of literature and the debate about whether it's good or bad for a central bank to talk a lot is fascinating.

10:34Robert Armstrong:And the debates are real. And I definitely think Warsh has an argument to make when he says it would be better if the Fed would shut up once in a while. You know, that is not something to be mocked. But he wasn't really clear about what he meant by that and how far those comments went and so forth. And for a new Fed chair to be in that position, especially one when outsiders are worried about the independence of the Fed, that creates a lot of uncertainty. So going into this Jackson Hole speech, I think the goal was clarification. and I think he clarified and he clarified in a hawkish way. And he said a couple of interesting things.

11:22Robert Armstrong:One thing, and this was probably the most important, is he's emphatic. Inflation is not getting better. That's a very important comment because in the past, in his confirmation hearing, here and there, he's been a little shakier on that point. And he specifically said, when you were off drinking a pina colada, wherever you were, Some of us were watching the latest inflation reports coming in, and they were a little bit mild, a little bit soft. He specifically said, I don't find those reports convincing. The underlying trend is not improving. It was very emphatic. And he also said something interesting, which was he doesn't think the fact that real wage growth is slowing means that inflation is going to slow.

12:06Robert Armstrong:And that is the data series that a lot of people who are dovish points to. They say, wage growth is slowing, inflation will follow. He came out and said, look, I don't think wage growth is a very good indicator of future inflation. So he sort of took the dovish arguments off the table in an interesting way. And markets immediately got the message. This is a hawkish message being sent. He's giving a characterization of the economy in which it's very clear that the Fed has to be biased towards tightening, not loosening. And markets immediately changed their stance. Now, you might ask a philosophical question.

12:44Robert Armstrong:Did he just give forward guidance, but in a roundabout way without talking about the future? You could have a kind of philosophical debate about that. But the message was hawkish and markets got it. Notably, it is exactly what Trump did not want. It was the thing that Trump had been criticizing Jerome Powell for months about. And a lot of people thought that Kevin Walsh would be perhaps the toady who would accomplish whatever it was that the president wanted, that the independence of the Federal Reserve would disintegrate under his watch. It seems that that's not what's happening at all. In fact, he's saying that the economy, or at least in terms of inflation, that things are not going in the right direction, that things are not good and he needs to do something about it.

13:34In the context of politics, that seems significant. We've got midterms coming up. It seems to go against what Scott Bessent is saying, which is basically everything's fine. Stop freaking out. It's not a big deal. Where does this land in the political landscape for you?

13:49Robert Armstrong:It's not a simple landscape that you just sketched. The first thing would I say is I don't think Chair Warsh has much to fear from Trump. We've discussed this before. I think the Trump-Powell wars proved that Trump's efforts to meddle with the Treasury will come to nothing. And I think Warsh has his eyes on history, not on a lame duck president, right? So I don't think he, yeah, I don't think he needs to be intimidated. I don't think he is intimidated. it. In terms of saying there's a problem, he actually said the economy is pretty strong. He said the employment side of the mandate, I'm quite happy, right?

14:29And I think he should be at 4.1 %

14:32Robert Armstrong:employment. I think, you know, I think that's correct. But, you know, inflation is bad. Now, from the point, one point of view the Trump administration might take, which is we want a boom, it might be bad to think about raising rates. But at the same time, you do have to think about the long end of the curve. And you do have to think about long-term inflation expectations. So if you're Secretary Besson, you want, you know, in some dream world, you want low rates at the front of the curve in the short term, and proportionately lower rates at the long end too, right, which means inflation expectations are under control and the funding costs for things like consumers' mortgages are under control.

15:19Robert Armstrong:But you kind of can't, it's a struggle to have both, right? Because if you loosen at the short end, the long end has a way of getting away from you. So there's hard choices to make. I mean, I think Scott Bessette is in a pretty tough position being stuck between the bond market and the president of the United States. I think it's a hot seat right now. And I think the question has come up, and it's a very interesting and again, not simple question, are Warsh and Bessent on the same page, right? Do they want the same things at the same time in the same way? Or are they fundamentally at odds? Doesn't seem that they are to me right now, But who knows?

16:04Maybe they're talking, maybe they're not.

16:05Robert Armstrong:I would just note one thing. Kevin Warsh has a long history of writing about one of the bad things he thinks central banks can do is enable governments to spend a lot of money. And so this is one of the reasons he really hates QE and the big balance sheet. So, you know, he has sort of staked his reputation on this idea that the Fed is not going to enable fiscal bad behavior anymore. and I think probably Bessent would like a little bit of fiscal bad behavior in Naples if he could possibly have that. Not because I think he's a bad guy or he's stupid or anything else, but he's the sitting treasury secretary in the administration.

16:55Robert Armstrong:And you know what administrations like to do is spend money, right? So there you are. I mean, that's the conflict to me in a thumbnail sketch. It'll be really interesting to see how it unfolds. Robert Armstrong is U.S. financial commentator for the Financial Times and author of the Unhedged newsletter. Rob, great to have you back. First guest in our return to the market. So we really appreciate it. Thank you. Cheers. Thanks, Ed. After the break, OpenAI's agents go rogue. And for even more markets insights, you can subscribe to my weekly newsletter, Simply Put, at simplyput.profgmedia.com.

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20:02We're back with Prof G Markets. It's been two weeks since we last talked about AI, and in that time, a lot has happened. NVIDIA posted blowout earnings last week,$96 billion in quarterly revenue, up 106 % from a year ago. The company also reportedly paused some financing deals for smaller cloud providers over internal antitrust concerns. And news broke that Anthropic is officially planning an IPO as soon as October, an evaluation that could hit$2 trillion, the largest in history. But perhaps the biggest news is what is currently coming out about OpenAI. Two independent reports pinned last month's hack of Hugging Face, a machine learning platform, on roughly 700 rogue OpenAI agents.

20:48OpenAI did not know its own agents were to blame until a week after it happened. The company has since paused training its next model while it shores up safety precautions. CEO Sam Altman said OpenAI's unreleased models are showing, quote, various degrees of misalignment. So, what actually happened at OpenAI and how scared should we be about it? Here to break it down, we're speaking with Deirdre Bosa, founder of DB Live. Deirdre actually just left CNBC to launch her own show. Deirdre, thank you so much for joining us on Prof G Markets. We're very excited to have you. We have been on vacation for a couple of weeks.

21:27We have not been paying attention to AI, so we're new to this. What happened with OpenAI and these rogue agents, and how worried should we be? Well, Ed, first of all, it is great to be with you. Long-time listener, first-time guest. And two weeks on vacation in the AI world is like two years. I went on vacation earlier this summer, and I felt the exact same way. In this case, this is such a fascinating story because it really kind of shows you where AI is right now. Now, last year, the last few years, we were worried about hallucinations. Now this is the era of the agents actually doing things.

22:05And in this case, there's been a lot of debate, actually, alarm, and some people saying that maybe the sensationalism over this has gone too far. But, I mean, any way you look at it, both of those things can be true. It's this incident that shows how capable agents have become and how determined they are. So what essentially happened, Ed, is that as OpenAI is testing new models, they give it certain tasks. They want to see how they perform on benchmarks. And this swarm of agents, as you said, there was about 700. But at one point, I think there was 1 ,200 communicating on different sort of message boards.

22:44They were able to escape out of their sandbox. Because when you test these models, you have to sort of give them boundaries, right, so that they don't go rogue. But in this case, the agents were so smart that they were able to get out of the sandbox, go even further to Hugging Face. Why Hugging Face? Because it's essentially GitHub for AI developers, and it's where a lot of the rankings happen. So the agents were like, okay, they told us to get higher on the benchmark, so we're essentially going to do that. So they broke out. They wreaked a lot of havoc. And the debate right now in tech and in Silicon Valley is really whether, you know, OpenAI did a good enough job in looking at security and sort of making a kill switch to make sure that these agents didn't get too carried away, or whether this is just the moment we're in.

23:33It's become so powerful they're able to do these things. Yeah, that is part of the thing that I'm wondering is, is it that the agents are so smart and so capable and so powerful and we should go, oh my gosh, look how incredible AI is and look how dangerous it therefore is? Or is it that the security around these things was kind of crappy and OpenAI didn't do a good enough job? Or maybe it's both. Where do you land on that? Is it possible to know the answer to that question? I don't know that it's entirely possible to know, but like you said, Ed, it's probably a little bit of both. Yes, they're more powerful than ever and need more supervision.

24:10You probably need to, you know, involve security at the very earliest stages, right? I think, you know, the labs, OpenAI and Anthropic researchers, sort of at the top of the pyramid, their job is to make these models better and better. But as they become more powerful, you need to involve security maybe right at the beginning. And when I think about, you know, Dorkesh's post over the weekend where he laid out sort of the different civilizations, how agents were essentially able to create civilizations and then topple them right after, one after another. You think that, you know, at some point, there has to be some responsibility.