Druckenmiller’s False Alarm About Treasury Buybacks
Stanley Druckenmiller thinks we should listen when the bond market speaks. His recent opinion column in the Wall Street Journal, however, demonstrates that listening is not enough. You also have to understand the language of the market.
The event that prompted Druckenmiller to deliver his translation of the market’s message was the announcement by the Treasury Department that it would increase the upper-limit of its repurchases of 10-, 20-, and 30-year Treasury bonds from $2 billion per reverse auction to $4 billion. According to Druckenmiller, this is an attempt to silence the bond market.
The trouble is that the evidence he present to support this idea shows nothing of the sort. He points out that long-term yields initially fell after the announcement and then quickly rebounded. “The market’s verdict was swift and correct: This wasn’t liquidity management, it was price management—and a mistake far larger than $4 billion suggests,” Druckenmiller writes.
In reality, this proves almost the opposite of what he claims. If Treasury were managing the price of the long bond, there would have to be a price it was prepared to defend. Yet the 30-year yield returned to where it had been, and Treasury allowed it to remain there. There was no yield target, no additional response, and no promise to buy however many bonds were necessary to hold rates down. It’s an odd sort of price management that does neither management nor price targeting.
The more plausible interpretation of the round trip is straightforward. Traders initially heard that Treasury would double its long-bond buybacks and assumed this might materially reduce the supply of long-duration securities. They then examined the details and realized that the change was far too small to determine the benchmark yield. The market resumed pricing long bonds according to all the usual things: inflation, growth, Federal Reserve policy, and the supply and demand for capital.
That’s actually what it would look like if the Treasury were doing liquidity management rather than price management.
Why Buyback Bonds at All?
Druckenmiller’s mistake begins with his assumption that liquidity support is justified only when markets are failing. He notes that there were no failed auctions, forced unwinds, or dealer seizures. But Treasury’s buyback program was never intended as an emergency rescue facility. Its purpose is to provide a regular outlet for older, off-the-run securities that trade less frequently than current benchmark bonds. The buyback program was never built to be a crisis response tool. It was created to manage liquidity in normal times.
An orderly Treasury market can still contain thousands of individual securities with varying degrees of liquidity. Older bonds may be harder for dealers to finance, hedge, and resell. They can trade at discounts to newer securities with nearly identical maturities. Buying some of those bonds reduces fragmentation and frees dealer balance sheets for other transactions.
Druckenmiller also misreads Treasury’s explanation that the operations had received “strong sponsorship.” He treats this as evidence of strong investor demand for Treasury bonds. Treasury was referring to something different: the large volume of competitively priced offers from investors seeking to sell old bonds into the buybacks. The long-end operations have routinely attracted offers many times larger than Treasury’s purchase caps. That’s a pretty sensible reason to enlarge it.
This Is Not QE or Yield Control
What’s more, the mechanics bear little resemblance to the yield suppression Druckenmiller describes. Treasury is not buying the current benchmark 30-year bond at a guaranteed price, which is what you would do if you were tryingt to cap the yield. It is soliciting competitive offers for older securities, comparing them with prevailing market values, and purchasing only those it regards as attractive. It can buy less than the announced maximum or nothing at all.
The securities are then retired, while Treasury continues auctioning new 10-, 20- and 30-year debt. The government’s financing needs do not disappear. The transaction replaces a scattered collection of older bonds with larger and more liquid benchmark issues.
Nor is this meaningfully comparable to quantitative easing or the Federal Reserve’s wartime yield caps, two other things Druckenmiller weirdly draws into the argument. From 1942 to 1951, the Fed committed to a ceiling on long-term yields and created money to buy whatever quantity of bonds was required to enforce it. In QE, the Fed promised to buy Treasuries and mortgage-backed securities at a guaranteed volume for an extended period of time, without saying anything at all about price; and it purchased these with newly minted reserves. The current buybacks have no yield ceiling, no price-insensitive commitment to buy a certain dollar amount, and no creation of central-bank money. The additional purchases amount to roughly $14 billion in a Treasury market exceeding $32 trillion.
Druckenmiller is also too confident about what the bond market is supposedly saying. He listens to the rise in yields and hears a warning about the government borrowing too much, a sign that inflation fears are worsening. But since the beginning of the year, the rise in the 30-year yield has come almost entirely from real yields. The inflation compensation embedded in the bond market has remained around 2.25 percent.
Higher real yields reflect stronger expected growth, increased demand for capital, heavy corporate borrowing, rising uncertainty, and higher prospective investment returns. (Some economists will insist we also mention a mythological creature called a “term premium,” but the less said about that, the better.) They also reflect the idea that the Fed will keep rates higher in the next decade than in the last, largely because growth will be more vigorous and the economy will no longer need near-zero rates just to keep the labor market from falling into a great depression. The market price of bonds aggregates all those considerations. It’s not singing Druckenmiller’s warning song about deficits or inflation.
Druckenmiller’s argument would effectively require Treasury to preserve avoidable liquidity premiums so that taxpayers, businesses, and mortgage borrowers experience enough pain to force Congress to act to reduce deficits. That is not responsible debt management. Treasury’s job is to finance the government efficiently while Congress decides how much the government spends and taxes. What’s more, it’s not clear that could ever work. Higher borrowing costs may slow the private sector, but it will not necessarily force elected officials to borrow less on behalf of the American people.
The Treasury’s bond buybacks are not aimed at silencing the markets. If anything, they are aimed at letting the market speak more clearly, without the background noise of off-the-run illiquidity. If Druckenmiller listened a bit more closely and with a bit more comprehension of the language of bonds, he might not misunderstand the message of accelerating growth that the market is sending.
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