Market Musings 220826: Bond Vigilantes take charge
Market Musings 220826: Bond Vigilantes take charge
The most important action this week in financial markets has been taking place in bonds. Specifically the largest, most liquid government bond market in the US.
Despite Treasury Secretary Scott Bessent's efforts to curb the rise in US long-term bond yields by buying back larger quantities of 10-30 year maturity bonds, the US 30-year bond yield has returned to a new multi-year high close to 5.3%. The rise in long-term bond yields is raising the cost of US fixed-rate mortgages and potentially raises the cost of servicing the $40 trillion stock of outstanding US government debt. In July this year, interest payments on this debt have already grown by $117bn (+14%) compared to the same period in 2025.
Chart of the week: new highs in long-term US bond yields (interest rates)
This is not just happening in the US - long-term government bond yields in the eurozone, UK and Japan are all rising in sympathy with the US. So governments in the developed world are all facing a similar problem of rising interest costs on historically high debt burdens.
This comes at a bad time for big tech companies who are increasingly borrowing money via the corporate bond market to fund their AI investment spree, as it also raises their cost of debt funding. Remember, these higher long-term interest rates represent an effective tightening of monetary conditions in the US, as it raises the cost of borrowing for consumers and businesses. So other things being equal, US economic activity should slow down in time as a result.
This creates an interesting quandary for the Fed President, Kevin Warsh. If he and the Federal Reserve decide to raise short-term interest rates, they will effectively be making this interest burden even higher on the US government, as it will raise the cost of issuing new short-term US Treasury bonds. It is no surprise then to see that the interest rate market is pricing only a 45% probability of a Fed Funds rate hike at the next Fed meeting on 16 September, 2026. Just 6 weeks ago, this was all but certain, with a 100% probability of a rate hike being priced into interest rate futures. Weaker core inflation and employment market data can help to justify the Federal Reserve keeping their benchmark interest rate at 3.50-3.75%.
FX: knock-on effect to the US dollar
The US dollar has weakened on the back of these moves in the bond market and the lower probability of a Fed rate hike in September. The uptrend in the US dollar evident for most of this year has now reversed, with the pound, euro and Canadian dollar all strengthening relative the the USD.
DXY US dollar index slips
I would expect further US dollar weakness to follow in the near term, as the US engages in even more drastic measures to stop long-term interest rates from rising even further.
Weaker dollar boost commodities
Commodities are the key asset class to benefit from a weaker dollar. Not only has oil rallied due to the lack of any evident US-Iran agreement and a reopening of the Strait of Hormuz, but both industrial and precious metals have resumed their bullish trajectories given supply-demand balances that favour higher prices.
Equal-weight commodities ETF close to a new all-time high
What weighs heavily on the world economy is not so much crude oil, but the cost of refined diesel fuel as this is essential for bulk transportation in the form of trucks, vans and ships. With refiners running at maximum capacity due to the reduced availability of refining capacity in the Middle East and Russia, refining margins are close to historic peaks elsewhere, driving up the cost of refined oil products such as diesel and kerosene.
European diesel prices at 2022 highs
To add to the strength in energy and metals, we can now add agriculture. Broad agricultural commodities indices are approaching new multi-year highs, approaching the highs set immediately after the outbreak of the Russia-Ukraine war in early 2022.
AIGA Agricultural commodities ETF breaks out of long-term downtrend
A notable agricultural commodity to show strength is coffee, one of the world's most consumer (and legal) addictive substances, with a number of health benefits to offer. Arabica coffee is already the most expensive that it has been since 2012
COFF coffee ETF could be setting up for a new strong uptrend
Agribusiness ETFs are a way to play this agriculture theme via companies involved in food production, and are following agricultural commodities higher.
ISAG Agribusiness ETF rallies
Oil & Gas, Mining sectors back to the highs
As you might expect given the strong performance of the underlying commodities, both Oil & Gas and Mining companies are leading the way higher in Europe and the US.
Europe Energy sector breaks out
Europe Basic Resources sector (Mining) lead too
Copper miners follow the multi-year high in copper prices (over $14,000/ton)
(COPX copper miners ETF, Freeport McMoran in the US, BHP in UK/Australia)
Watch long-term bond yields - any higher and there could be a correction in stock markets
While a weaker US dollar is often bullish for global stock markets, higher long-term borrowing costs could lead conservative investors to switch from stocks increasingly to buying bonds to lock in these historically high yields of over 5% in the US and UK. Even in Japan where interest rates were around zero for decades, a 30-year government bond can offer a 4% yield for the first time in a very long time. This is all a reminder that we now live in an era of fiscal dominance, where the huge debt burdens of governments around the world increasingly dictate not only the fiscal policy of governments, but also the monetary policy set by central banks.
We are in an era where inflation is likely to run above 2% for extended periods of time, and where so-called real assets like commodities, infrastructure and inflation-protected bonds become a key pillar of long-term investment portfolios as a result.
My personal portfolio remains heavily biased towards commodity production in the long term as a result, in spite of the high volatility that it has suffered since February.
Edmund
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27 comments
It's not just the Strait of Hormuz that has 'issues' at the moment. It's interesting to note The Panama Canal is suffering from drought conditions due to the El Nino weather phenomenon.
https://tinyurl.com/yernxzas
Interesting discussion in this weekend's IG Index podcast 'The Art of Investing' around bond yields. It has been widely reported that US Treasury Secretary Scott Bessent was involved in the London operation of George Soro's hedge fund back in the early '90s when the UK was forced out of the ERM but apparently it was in an office mgt type capacity. It was Stanley Druckenmiller who was the brains behind the hedge fund's best ideas.
And so it was interesting to see the latter write in the WSJ last week in a piece titled 'Let the Bond Market Speak'.
https://tinyurl.com/2xe782jd
I don't have paid access to the WSJ but the following is useful in understanding what the article said.
https://tinyurl.com/3mzj3s3h
It seems that Kevin Warsh is not the 'yes man' that a lot of people thought he would be. And the only sensible way to bring down yields is to reduce the annual deficit.
It's almost certainly the same story for the UK, France etc. Regardless of the country, it simply doesn't make sense to separate monetary and fiscal policy.
Any thoughts on the 9 Sept bond buyback and Trump's share dealings. Rotating out of tech and into Visa, Mastercard and Berkshire to name a few. Given his recent track record of prior info before it hits the market, is there anything interesting here?
Good article and it articulates a number of concerns I have with US fiscal issues. Trump has still not learnt that he is in hock to the Bond Markets and can do nothing to escape the on coming train. I notice several Strategic Bond Managers have pulled maturities back to the short end which is pretty indicative of the concerns echoed in the article. I am afraid the people involved are at student level of literacy in economics and this does not bode well
Perhaps we should celebrate US mortgage rates moving higher as well as the cost of Gas as it surely means Trump is going to have a tough mid term outcome. Trump as a lame duck seems a pretty frightening prospect...
with regard to the uk - the only sensible thing RR did was to have plans to stop our national debt growing in real terms by the end of the parliament. dont get me wrong imho that target probably wasnt ambitious enough and i dont trust any politician not to ignore their promise that and change tune at election time to temporarily give away freebies based on "more positive outlook"
anyway - i think AB that while AB seems to at least be doing something - i am am worried that he will backtrack on that promise on the basis we need to invest. So unfortunately it looks like we will be back to our bad ways of being the same as Trump.
very sad that all political parties seem to ignore the basic fact we need to not spend more than we can afford other than at "certain times" - to me those times are when we have had a clear real recession (like 2008) or an event like covid where spending was clealry necessary. That should be don on the basis though that that spending is clawed back over reasonable period of time.
What is sad is that if we tackled the imbalance which might be like betwen 1-3 of spending per year year - well our country would be on a stronger footing - and our pople would be better off as the debt markets would be coming to us for security - rather than saying lets take on the uk as they clealry cant balance the books.
Personally i would put a pool of times served dinner ladies in charge of the basic of "living within our means" - i dont doubt that would include tough choices the current lot though are universally a joke and are probbaly all happy to steal from futrure genereations - i may perhaps concede that some can say "well i tried and was unlucky due to circusmtances that came along" - i suspect they are ones who simply didnt get to the stage where they had the opportunity to hand out your standard "election bribe"
hey ho we and the us are at the mercy of the markets - the us being the us probbaly has the power to do what it wants and will always get away with it with teh dollar being the worldwide defacto currency (for now) - as a bit part player we arent so lucky with regard to what we can do.
you are kinda revelling in the fact that times are tougher for those at tehn bottom when stuff like this happens - i get it that you wnat to see trump geta good kicking for the way he has acted - but the real losers here are those at the bottom that really struggle to make ends meat (your average lower earning worker) when inflation goes up
Don't disagree with any of that I think the other issue is even if a leader did what was needed and got the debt down the electorate won't want their treats taken away and the party trying to balance the books would be booted out four years down the line. The next lot would come in and most likely run the UK credit card back up to maxed out in their term. Sadly as we know all choices are most likely bad ones moving forward.
I think the other issue is even if a leader did what was needed and got the debt down the electorate won't want their treats taken away and the party trying to balance the books would be booted out four years down the line
I would love that to be put to the test - only by putting it to the test would be find out if the silent "proportion of the electorate" that dont want to live beyond "our means" would be the the silent majority - most older people i know dont want to be borrowing from their kids and grandkids. If the 20 year olds are happy loading up debt let them do that - but its a bit sad if us older lot would vote out a party that "does the right thing" in that regard.
I'm realistic enough to think the triple lock has to go sooner rather than later but I think those of us who understand the seriousness of the situation are in the minority.
The triple lock is madness- I am drawing a state pension.
The right thing to do would be to start cutting the size of the Civil Service and holding the senior staff there to account for all the badly implemented and over budget projects they preside over.
The size of it is 36% higher than in 2016 - I think you'd struggle to find anyone who would agree that has resulted in tremendous improvements in Government performance.
Cutting Government spending doesn't have to equate to cutting NHS or other frontline services...
Hi RM
No celebration my friend only the desire to see Trump emasculated from further damaging the pockets of workers. I have friends in US and it is tough for the people. Trump planned mashing of Healthcare is hitting even harder. I spent time in mid west states and you do not need to go far to understand real poverty exists. The impact of AI on jobs is already being felt and this will impact further as it develops. The extremes of weather are becoming more difficult for Farmers and Trump already gives them huge subsidies. Tarriffs are seen for what they are protectionism. CSE level economics I think
As to the UK some of AB's ideas are correct but it is the execution that is all. Until someone has the guts to tackle the welfare issue or stops creating issues that are well intentioned but badly thought through ( Renters rights etc is a classic example ) stagnation appears the outcome
As to the UK some of AB's ideas are correct but it is the execution that is all
exactly - hey ho Leicester did win the league and not many saw that one coming before the start of the season
Yes and they are my team sadly playing in the lower leagues and with the worst choice of manager possible.....
Good free write-up from Scott Rubenstein on Substack on Friday, repeating much of what Edmund has said above re: US Treasuries....
It’s Scott Bessent’s birthday today. He’s sixty four. Rather than doing the garden, though, digging the weeds, the US Treasury Secretary has been intervening in bond markets. In an effort to stem rising yields, Bessent announced that his department would ramp up purchases of longer-dated government securities. “We shall scrimp and save,” sang McCartney. Not so, Bessent.
As Treasury Secretary, Bessent sees himself as “the nation’s top bond salesman”. It’s a big job. In fiscal year 2025, his department issued a total of $30.2 trillion in marketable securities to investors in over 400 auctions. “The Treasury market remains the deepest and most liquid market in the world,” he touted in November, “a testament to the efficacy of the Trump Administration’s economic policies.”
But by Bessent’s own yardstick, his performance has been slipping. “Treasury yields are a strong barometer for measuring success,” he said of his role. In the most recent auctions he has conducted, yields have lurched higher. A $42 billion auction of the 10-year Treasury note on August 12 pushed the auction yield to 4.683%, the highest level since 2007. The following day, a $25 billion sale of the 30-year Treasury bond resulted in an auction yield of 5.216%, the highest level since 2001. Investors showed up, submitting bids worth around 2.5 times the debt on offer, but they demanded a higher return to do so.
With outstanding debt of over $40 trillion, interest costs are mounting. At over $1.2 trillion on an annualised basis, the cost of interest on government debt now exceeds what the US spends on national defense – the first sustained occurrence of this in the post World War II era. Combined with entitlements, annualised net interest rose to 98.4% of government receipts in the 12 months to July, up from 96.2% in 12 months to June, and the highest level since the record 99.7% in the 12 months to June 2020 when the Fed was engaged in Covid-triggered monetisation.
Seasoned risk managers are worried.
With outstanding debt of over $40 trillion, interest costs are mounting. At over $1.2 trillion on an annualised basis, the cost of interest on government debt now exceeds what the US spends on national defense – the first sustained occurrence of this in the post World War II era. Combined with entitlements, annualised net interest rose to 98.4% of government receipts in the 12 months to July, up from 96.2% in 12 months to June, and the highest level since the record 99.7% in the 12 months to June 2020 when the Fed was engaged in Covid-triggered monetisation.
Seasoned risk managers are worried.
Stan Druckenmiller: “The fiscal recklessness of the last decade has been like watching a horror movie unfold.”
Ray Dalio: “Debt service is like plaque building up in the arteries… When you get to the point where we are, which is very close, that you have to borrow money to pay the debt, then that is the problem.”
Ken Griffin: “If your fiscal house is not in order, the bond vigilantes can come out and extract their price.”
Jamie Dimon: “The way it’s going now, there will be some kind of bond crisis, and then we’ll have to deal with it. And it will be okay, it’s just not the way to do it.”
David Solomon: “If we continue on the current course, and we don’t take the growth level up, there will be a reckoning on this.”
Jeff Gundlach: “The long-term Treasury bond is not a legitimate flight-to-quality asset. It’s not responding to lower interest rates… The reckoning is coming.”
Even everyday risk managers are concerned. In a recent survey of bond investors, registered voters and economics or finance graduates, respondents put the odds of a crisis within ten years at close to 50%. Among investors, simply being shown the current debt level and the Congressional Budget Office’s long-run projections raised their stated ten-year crisis probability by 14.9 percentage points.
While a full-blown crisis may be some way off, casualties of higher rates are mounting. Back in 2023, the banking sector was first to experience the aftershock of rising rates when Silicon Valley Bank collapsed. This month, United Wholesale Mortgage, the nation’s largest mortgage lender, was forced into a bailout as it, too, floundered on persistently higher long-term rates.
To explore whether this is the start of a reckoning, and why Bessent felt compelled to intervene in markets, read on...
Are you able to supply a link to the article Shoeshine I haven't been able to find it on Substack thanks in advance.
Hi Phoenix, my bad, it wasn't substack but a separate site called net interest, don't recall how I came across this but I do get some interesting free emails. Here's the link, hope it's useful....
Great Scott - by Marc Rubinstein - Net Interest
Jeremy McKeowns piece on his stubstack about the $40 trillion debt pile is a good read. Surprisingly he manages to get Ayn Rand and George Orwell arriving at the same conclusion, you can make your own mind up !
https://jeremymckeown.substack...
Another marker to note : Brent Donnelly points out : PIMCO 25+ Year Zero Coupon US Treasury Index ETF (PCQ:ZROZ) had their biggest volume day on record - the day before Scott Bessents announcement... I personally am not surprised.
Excellent article and insight Edmund, thank you - even if this analysis gives me a slightly uneasy feeling about being invested in tech and the s&p, it seems a correction could be on the horizon.
I do have a decent amount of exposure to mining and emerging markets, which, I think, should benefit from a weakening dollar.
I'm keeping an eye on bitcoin and took a position in microstrategy this week - bitcoin looks to be bouncing off the bottom of a long term channel, possibly signalling the start of a new move upwards. Worth watching i think.
With big tech all chasing and overspending in the race to develop AI at a speed faster than it can be economically employed, you are right to be expecting a correction in the value of S&P holdings, but with Trump making such a mess of the American dollar, you are better placed to hang on with your mining and emerging market holdings. Whatever happens never consider cryptocurrency and Bitcoin may provide a better investment. Instead enter Bitcoin into the search bar and read the excellent article by Ed Croft all the way back when it first started entitled," Is Bitcoin the World's most perfect Speculative Material". Hopefully after reading it you may share the view that it is a massive Ponzi scheme only really useful for money laundering funds, one would rather not be traced from criminal activity. The only channel it gets a lift from is Trump's own "Truth Social" platform.
If US based or have access to these Commodity ETFs ,type the following into a search engine..
"compare overall return, price increase and yields for pdbc pit cery hard and bci. No K-1"
(Ignore AI attempts to change CERY to VERY). You get 5 funds with various ways to extract wealth from commodities (and from you) without dealing with burdensome K-1 tax acrobatics.
I already owned PDBC and BCI but I had never heard of the others till I read this excellent article and then did this search.
Interesting. 25% of US debt is Trump inflicted. Rising yields for many reasons including lack of confidence in US paying back their debt, does anyone have confidence in Trumps US anymore, oil ;) war, etc. Bessent (copilot) apparently didn't buy any this week just committed to buying double from 2 to 4 billion as part of an overall package which is a drop in the ocean of overall debt.
Who knows what impact Canadian trade war will have on the dynamic. Kudos to Carney to be the 1st (I hope of many) to take the fight back to the US and stand up to the spray tan.
Other commodities moving significantly gold and silver and related miners. Uranium up a lot on Friday too.
Interestingly, no value crypto is up 30%+ so Trump personally will sill be gaining from his market and financial games.
I do hope the McDonalds and age finally works it's magic.
Since 2020, recent administrations did their very best to deal with mandatory spending which is 60% of the budget. Unfortunately for the budget and Federal Debt many of us boomers refused the poisoned needle, hospital "protocols" or somehow muddled through to survive the plandemic and continue to collect social security, medicare and medicaid. I feel like I am in Monty Python movie "I'm not dead"
The problem is: if not Trump, who would better deal with his handlers?
I've thought the debt would do for the West for years now but they proved master can kickers, but due to Trump seemingly wanting to destroy the system that has worked since world war 2 he has certainly shortened the timeline to when the massive blow up finally arrives.
Although he comes across poorly on tv I do think Bessent is one of the few competent people Trump has around him but equally I do also think the West is finally running out of options.
Its strange how its all playing out Japan was stuck in low growth and low interest rates for years which in hindsight was where they needed to stay but they then started to get economic growth, which caused inflation to awaken and the shoe's started to drop.
Another excellent insight, Edmund. I always look forward to your perspective.
Hi Ed. Thanks for the insight. Difficult to know whether to chase commodities here. A weaker dollar is bullish but higher yields will eventually cause a correction in all risks assets. I’m cautious ATM especially at this time of year.
Thanks Edmund - as ever, insightful and a good perspective
Yes indeed. Many thanks! I always look forward to weekend Market Musings.