Here's How Bessent's Newly Activist Treasury Department is Undercutting the Fed's Warsh

Markets were already on edge after Fed Chair Kevin Warsh's most recent press conference, and Treasury Secretary Scott Bessent's remarks this week have added to that.

The surprising move this week by Treasury Secretary Scott Bessent to intervene in Treasury markets to lower the cost of government debt undercuts the credibility of Federal Reserve Chairman Kevin Warsh to make interest-rate policy, experts said.

After 30-year Treasury bond rates hit a 19-year high, Bessent said the government believed the increase was not driven by fundamentals. He announced plans to intervene in the market and said the government would buy long-term bonds and finance the purchases by selling short-term T-bills. This will "twist" the yield curve, he said, by pushing long-term rates lower and short-term rates higher.

At the same time, President Donald Trump repeated his call for the Fed to lower interest rates.

The move by Bessent coupled with Trump's continued pressure "gives you hints of a potential erosion of the Fed's independence and certainly questions around the Fed's credibility and Warsh's credibility when it comes to making policy," Gregory Daco, chief economist at EY-Parthenon and president of the National Association for Business Economics, said in an interview.

Bessent's action shows a desire by the Treasury Department to have greater control over market pricing.

"There is a risk, if you extend this thought process, that we have entered into an environment of fiscal dominance, where essentially the Fed is taking its instruction from the Treasury and delivering upon a desired outcome of lower long-term interest rates," Daco said.

Bessent's comments this week that bond traders had misjudged the fundamentals of the economy are at odds with Warsh's comments at his press conference last month, where he welcomed the higher rates as doing some of the work for the central bank by putting downward pressure on inflation.

Warsh remains something of an unknown for financial markets. He built a reputation over the past 20 years as a hawk who generally favored higher interest rates to cool inflation, even at the expense of the labor market. But the market doesn't know how much his wings were clipped when the Trump White House tapped him to serve as Fed chair.

In his public comments since taking over at the helm of the Fed in May, Warsh has resolutely declined to give any clues about his thinking about the future path of interest rates or give his opinion on the steady stream of economic data that informs Fed decisions.

Warsh will speak at the Fed's summer retreat in Jackson Hole, Wyo., next Friday. The market pays close attention to the Fed chief's remarks at this event, which comes at the end of the summer lull and where shifts in Fed thinking are often laid out.

Bessent has opened up a couple of cans of worms, said Lou Crandall, chief economist at Wrightson ICAP, which makes it harder for the Fed and the Treasury Department to communicate to the markets.

"Suddenly nobody knows what the real message is," Crandall told MarketWatch. "Bessent has opened the door to a lot of speculation about what authorities might have up their sleeves."

This can be tactically useful in the short run to keep long-term yields from spiking. But Crandall said that in the long run, it will raise the interest rates on money the government borrows, increasing the cost to taxpayers.

Markets were already on edge after Warsh's last press conference, and Bessent's remarks just add to that.

"The Treasury has invested decades that it would not behave opportunistically like this," Crandall said.

Warsh and Bessent meet once a week for breakfast or lunch. Little is known about their discussions.

Markets are wondering what tools Bessent might use to keep rates lower, and if he wants the Fed to step in.

"It opens the door for all sorts of conspiracy theories, and I can't really shoot any of those down. That's the problem," Crandall said.

After World War II, Federal Reserve officials wanted to stop helping the Treasury Department keep interest rates low, leading to a fierce struggle with the Truman White House.

The result was the Treasury-Fed Accord of 1951, which lets the Fed set short-term rates independent of the Treasury Department.

In his campaign for the top Fed job, Warsh said he was open to a rewrite of the accord, but he hasn't given any specifics.

Even if the Treasury Department wanted to do something in coordination with the Fed, most top Fed officials would say no, according to Ira Jersey, chief U.S. interest-rates strategist at Bloomberg Intelligence.

Even Warsh has called for a smaller Fed balance sheet and for the central bank to sell long-term securities and move toward holding shorter-duration Treasury notes, while Bessent would want the Fed to buy more at the long end, Jersey said.

One of the risks for Bessent if he launches a large-scale "Operation Twist" - which refers to a program of buying long-term Treasury securities and selling short-term ones to lower long-term interest rates - is that if the Fed needs to hike rates to combat inflation, it will add to the widening federal budget deficit.

Marco Casiraghi, senior economist at Evercore ISI, said Bessent's plans don't kill any chance of a rake hike. In an interview, he said the twist program would lead to a weaker dollar, which at the margin means more inflation.

Bessent pushed back this week when asked in a CNBC interview if his moves tie Warsh's hands. He said the Treasury Department and the Fed "would work together if there was any change in the balance sheet," and that his department "would adjust to any kind of runoff that they're doing."

When pressed on whether his moves would be problematic for Warsh's Fed if it has to raise rates, Bessent said "that has nothing to do with the decision that I announced this week on the buybacks." He didn't elaborate.