As Inflation Proves Stubborn, Global Bond Crisis Looms
Bond markets are shuddering at the thought of the spending needed to maintain growth.
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As the first half of the year ends, the S&P 500 closed at new highs near 6250, up 7% for the year.
If one went through all the news headlines and macro tape over the past few months, we could not have had a choppier, more uncertain time. The market was down 15% in four days in April, suggesting the world was about to end as the U.S. and China were going head to head, taking tariffs up in multiples of tens aimed to crush the other's economy with the entire world falling victim to their ego games.
As President Trump took office, his aim has been to get money flows and power back to the U.S. — MAGA in all ways. One of the key points to his agenda was to lower the fiscal deficit so that he could carry on with his fiscal spending plans and tax cuts for the future. But with a starting U.S. national debt closer to $36 trillion and interest rates close to 4.5%, his hands are tied. It is one thing to try and renegotiate tariff rates with other exporting countries and another to coerce them into a harsh fix on day one.
The Joe Biden administration, along with ones before it, had just kept on spending willy nilly with no accountability whatsoever, kicking the can further down the road as the path to any problem was to print more, each time in multiples higher than the time before, to resolve the crisis. Today, with U.S. debt highest since World War II, it is no wonder that the bond markets are worried about funding just the existing debt, let alone new issuance to come.
The U.S. bond market knows there is about $9 trillion debt that needs to be refinanced as rates get reset from the low levels of 1.5% to 2% to the current level of 4.5%. This is why President Trump needs rates lower to release his hands, but the Fed is hesitant to do so, as the economy is holding up and CPI super core inflation is still averaging close to 2.9%.
It took them all of 2021 to 2022 to get inflation down post the COVID surge, when they refused to believe it was not transitory, so they are quite sensitive to making the same mistake again. Once the inflation genie is out of the bottle, it will be too difficult to get it back in without repercussions — the 1970s taught us that.
The U.S. bond market has always been the one market that has taken any central banker and even a president hostage. Last fall, U.S. 10-year yields got close to 5% that caused havoc in the markets and allowed the treasury to be creative by issuing more near-term T-bills to avoid having to issue debt further down the curve, lest yields got out of control.
These financial games are being played by the treasury, buying time essentially, until interest rates come down enough so that they can issue more debt to refinance their spending plans, according to the "big, beautiful bill." The only problem is that the U.S. labor market is not cracking nor is inflation subsiding. This phenomenon is not just isolated to the U.S., but also occurring in Japan and Germany where German 30-year rates are at the highest since 2023, around 3.22%, and Japan is surging to new records as well with its 30-year government bond yield trading at 3.15%, almost close to the highest since 1999. Global bond markets are shuddering at the thought of what their central banks and governments have to spend in the future just to maintain the growth that they have promised their economies.
Debt to GDP only works if the latter can overtake fast enough to offset the former's increase. For now, the debt is going up faster than GDP and there is a lot of hope in AI to fill that productivity gap, which it will. The only question is how fast that will be before developed markets face a bond market crisis. For now, equities seem to be focusing on the resilience of the economy, but at some point, the weight of the debt and higher yields will cap that progress.
