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 Stop Press: This was our subject line at noon today, given the relatively calm week in markets. Then Trump announced 50% tariffs on all goods from the EU. This is the nature of the new era: more shocks, more volatility, and even more reasons to be prepared.
Hi
Cracks in bond markets are growing, and this is important for the equities outlook.
This is just the last week... Governments are over-borrowing, bond investors in the US and Japan are pushing back, government bond yields have been spiking higher to attract reluctant institutions to buy new issues…
Economic activity is anaemic in the UK and Europe. Ordinarily this would encourage expectations of somewhat lower interest rates. But UK inflation was unexpectedly higher, prompting one Bank of England rate-setter to warn that we shouldn’t expect sharp rate cuts with inflation so volatile…
Oh and in the UK, new tax increases appear all but inevitable as government spending is higher than expected.
The primary attention of global investors this week has been on the US government bond market. Trumps “big beautiful” tax cutting legislation, working its way through Congress now, will reduce government income, and require even more bonds to be issued to fill the hole in the government coffers. No, that doesn’t make sense. The bill will give money to the wealthy and takes it away from the poor. Nor does that make sense – economically, politically, socially. One bank called the debt outlook “completely unhinged”.
Although the trajectory of US debt has been clear for 20 years or so, what was unknown was when “the system”, reliant on a global army of willing buyers of government bonds (debt), would break.
In my experience, ahead of major breakdowns in financial markets, warnings build over weeks and months… then the final act seems to come out of nowhere, overnight.
The warning signs are certainly building. Money being withdrawn from existing US assets of all kinds, notably less enthusiasm to buy new US government bonds. US Treasury yields going up, implying a growing lack of trust, which is not just based on the economics but the seeds of uncertainty which Trump has sown into the foundations of US leadership, domestically and globally.
20 and 30 year bond yields are now around 5%, and the risk is that they could spiral somewhat higher, causing chaos in US And global financial markets.
For example, as US government bond yields go up, the greater is their interest payments to bond holders. As that interest bill goes up, so does the concern of wary investors. So interest rates (yields) have to go up, to compensate investors for this perceived extra risk… meaning that the interest bill goes up again… and on and on… it’s self-perpetuating.
This is even worse because large parts of that interest rate bill is on existing bonds issued when yields were a lot lower. As they mature they get rolled over into new bonds (i.e. bonds issued to cover government deficits in past years) with much higher yields. For context, one-third of the total Treasuries market will mature in 2025, which is huge.
Of course bond investors knew this was coming, which is one very important reason why yields have increased compared to 2024. What they hadn’t factored in was Trump.
“Debt calamity threatening the west…the idea that countries don’t go bust is a joke … the debt trap may be about to spring… a crisis of political stability will be played out over the next 18 months...“
Well, that’s a helluva prediction. Except that it was in May 2009, the words being those of historian Niall Ferguson reported in the Guardian.
The trap for analysts of all persuasions (from history buffs to number crunchers) is to do great evidence-based research on where we are today and how we got here… and then make a prediction on the timing of the next big market event.
This brings you back to controlling what you can control, and having to accept the extreme vulnerability, in US equities and US and global government bonds.
Equity markets are, as yet, not unduly concerned by these bond market shenanigans. Last week we noted the ABC correction patterns in US and Japanese stock markets. The same is also observable in China’s CSI index and in gold. The implication is more upside in all these markets in the weeks ahead.
Enjoy the long weekend.
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