Us Treasuries are heading for the "biggest bond bear market ever".
As the "anchor of global asset pricing", the 10-year US Treasury yield hit a 16-year high in the past week, soaring as high as 4.89 per cent. The 10-year Treasury has fallen 46% from its March 2020 peak, which is close to the 49% drop in the U.S. stock market after the dotcom bubble burst in 2000.
The 30-year bond has plunged 53%, close to the 57% drop in U.S. stocks during the financial crisis.
McCarthy, the No. 3 figure in American politics, became the first "victim" of this round of US debt storm. But it won't be the last.
Number one casualty
On October 3, local time, the House of Representatives of the United States Congress passed the "removal motion" for House Speaker Kevin McCarthy with 216 votes in favor and 210 votes against, making McCarthy the first speaker of the House to be removed from office in the history of the United States.
In January, McCarthy took 15 votes over five days to become speaker. It is also considered to be the most difficult election in 164 years.
In just nine months, the beginning and end of McCarthy's career as Speaker made history.
Mr McCarthy's ouster was triggered by the threat of another US government shutdown, just three months after the last one.
On September 30, just hours before the US government was about to shut down, McCarthy, as the leader of the Republican Party, finally chose to compromise with the Democrats and passed the temporary budget bill, so that the federal government could continue to operate and avoid a "shutdown" due to funding problems. But the bill did not include the deep cuts in federal spending and stronger border controls that House Republican "hardliners" had demanded. On October 2, Republican U.S. Representative Matt Gaetz filed a motion to remove McCarthy from office.
The temporary funding bill, which McCarthy shepherded through Congress, is good for 45 days and funds the federal government through November 17. If Congress fails to pass legislation to provide more funding, a partial government shutdown will begin Nov. 18.
The reason why McCarthy was ousted this time is related to the political disputes between Democrats and Republicans, but the root cause is the US debt issue.
As it stands, the U.S. government cannot operate without issuing debt. According to data released by the US Treasury Department, the US national debt surpassed $33 trillion for the first time in September this year, once again hitting a record high. In June of this year, the national debt had just passed the $32 trillion mark.
Total U.S. national debt (in billions of dollars) Source: Choice
This means that in the past three months, another $1 trillion of Treasury bonds have been issued.
At present, the Federal Reserve is in a vigorous cycle of interest rate hikes and balance sheet contraction. Without the Fed as a big buyer, the US government's massive issuance of bonds can only be borne by the market, which will lead to tight liquidity in the US bond market, the US bond yield will soar, and the US government will have to issue bonds at higher interest rates.
Maya McGinias, president of the Board for Federal Budget Accountability, said in a statement: "The United States has reached a new milestone that no one can be proud of, with our total national debt just over $33 trillion. We're becoming desensitized to these huge numbers, but that doesn't make them any less dangerous."
Kidnap global assets
U.S. Treasury bonds are widely regarded as the standard "risk-free asset," and their prices are used by Wall Street analysts as the "pricing anchor" for securities assets around the world. In other words, the value of securities such as stocks is determined by reference to the yield on U.S. Treasuries.
The recent plunge in the price of US Treasuries has rattled global markets.
Eastern time on October 6, the United States Bureau of Labor Statistics released the latest employment data, in September to add 336,000 non-farm employment, far more than the outside world expected 170,000. That followed upward revisions of a combined 119,000 to 236,000 and 227,000 in July and August, respectively.
The strong jobs data raised expectations of further interest rate hikes by the Federal Reserve, sending Treasury prices diving and yields rising. The yield on the 30-year Treasury bond once exceeded 5%, and the yield on the 10-year Treasury bond once approached 4.9%, a new record since 2007, and a rise of more than 40% compared with the yield levels of 3.40% and 3.52% at the beginning of this year.
The largest long-bond fund in the U.S. capital markets, the $39 billion iShares 20-Plus U.S. Treasury ETF (TLT), has fallen 48 percent from its all-time high in 2020, almost halving. On a year-to-year basis, the iShares 20-plus Treasury ETF is down about 10 percent this year, after falling 33 percent last year.
Another result of the surge in yields has been a rebound in the dollar, which has gained about 7% on average against G10 currencies since mid-July, when Treasury yields accelerated. The dollar index, which measures the greenback's strength against six major currencies, is near a 10-month high.
The spillover effects of the spike in US interest rates inevitably spread to global bond markets.
The UK's 30-year gilt yield rose to 5.1 per cent on October 4, its highest level since September 1998.
German 10-year bond yields, which have always been solid, climbed to 3%, back to the highs of the European debt crisis in 2011.
In Japan, where interest rates remain ultra-low, the yield on 10-year government bonds took a rare step above the 1 per cent mark.
Even Australia suffered a double kill, with its 10-year bond briefly plunging faster than its US counterpart.
For the United States, the pain of soaring Treasury yields has also been transmitted to the stock market, the banking sector and the housing market.
Since September, all three major stock indexes in the United States have fallen sharply. The Dow Jones Industrial Average fell 3.79%, the S&P 500 dropped 4.42% and the Nasdaq fell 4.3%. On October 5, a filing with the US Securities and Exchange Commission (SEC) showed that Apple CEO Tim Cook sold about $41 million worth of stock, the largest sell-off in more than two years, reflecting Cook's expectations for Apple's future stock price trend.
High interest rates are also a heavy burden for companies, and companies that can only issue debt in the high-yield market will face sharply higher borrowing costs. The Federal Reserve's FRED economic data shows that the easy lending conditions in the early days of the COVID-19 pandemic have pushed corporate debt to a record high as a share of GDP over the past three years. It also means companies will have to face higher yield market conditions when they refinance, forcing companies to cut spending and investment.
As bond yields and mortgage rates rise, the pain will be more pronounced. The 30-year fixed-rate mortgage - the most popular home loan in the United States - has risen to its highest level since 2000.
Peter Boockvar, chief investment officer at Bleakley Financial Group, said: "This is an interest rate shock for anyone with debt coming due." "For any real estate person with a loan coming due, any business with a variable rate loan coming due, it's tough."
The spike in interest rates has also put pressure on regional banks that hold bonds that have fallen in value, one of the key factors in the collapse of Silicon Valley Bank and First Harmony Bank. While analysts do not expect more bank failures, the industry has been looking to sell assets and has scaled back lending.
Financial conditions are tighter today than they were then. Banks now have the Federal Reserve's Term Funding Program (BTFP) as a backstop, so there is no risk for the time being, but in six months, the BTFP facility will expire. The negative impact of high interest rates on financial markets may be further transmitted in the future.
Lindsay Rosner, head of cross-asset investing at Goldman Sachs, said, "We're 100 basis points higher now than we were in March." "So if the banks haven't solved the problem since then, the problem is only going to get worse because interest rates are only going to go higher."
Since the Fed began raising interest rates last year, there have been two financial upheavals: the "UK debt crisis" in September 2022 and the US regional banking crisis in March this year.
Bob Michele, jpmorgan's chief investment officer, said another move higher in the 10-year Treasury yield would increase the likelihood that other factors would collapse and make a recession more likely.
"If long-term interest rates go above 5 percent, it's clearly another interest rate shock," Michel said. "At that point, you have to keep your eyes open for anything that looks fragile."
How the Fed ends
The surge in US bond yields is fundamentally an imbalance between supply and demand.
On the supply side, the US government will continue to run high deficits for the foreseeable future, which means that the massive issuance of debt will continue. The U.S. Treasury Department plans to issue a net $1.01 trillion and $852 billion in Treasury bonds in the third and fourth quarters, respectively. At the same time, the Federal Reserve is continuing to reduce its holdings of US Treasuries through quantitative tightening, and its holdings have fallen by $1.3 trillion since 2022, which is equivalent to increasing the massive supply of US Treasuries.
On the demand side, overseas investors have reduced their holdings as a whole, with total debt holdings reduced by $121 billion since 2022.
Among them, with the Bank of Japan's yield curve control (YCC) policy ceiling raised, the possibility of monetary policy normalization gradually increased. Once the Bank of Japan adjusts monetary policy, demand for Treasuries will weaken significantly.
In the face of the impact of the strong dollar, the local currencies of the majority of emerging market economies have depreciated significantly, which has intensified the possibility that economies will sell US Treasuries to defend their currencies.
As overseas demand continues to weaken, supply pressures are being transferred to the United States.
But the reality is that the U.S. has limited domestic capacity for large-scale bond purchases. A liquidity crisis hit U.S. banks in March, hampering their ability to absorb U.S. debt, especially long-dated securities.
U.S. debt continues to breach its ceiling, but long-term buyers are stretched thin. Where else could unbalanced supply and demand push Treasury yields higher?
Nick Timiraos, a journalist dubbed the "new Fed wire service", has warned that the surge in US long-bond yields is destroying hopes of a soft landing for the economy, with a surge in borrowing costs that could sharply slow economic growth and increase the risk of a financial market meltdown that could weaken the case for the Federal Reserve to raise interest rates again this year.
Indeed, the Fed itself is experiencing a once-in-a-century loss.
Affected by the previous balance sheet expansion and interest rate hikes, the Federal Reserve's net operating loss in the first half of 2023 reached 57.384 billion US dollars, and the net operating loss for the whole year may exceed 100 billion US dollars, and the Federal Reserve last reported annual net operating loss in 1915.
If the Fed loses money, U.S. federal revenue will be directly affected, and the Treasury Department may not continue to receive net profits remitted by the Fed until after 2026.
While net operating losses and unrealized gains and losses do not have an impact on the Fed's monetary policy, they could make it more difficult to fight inflation.
In addition, if required to comply with the provisions of the Federal Reserve Act, the Fed could require the regional Reserve banks to pass on operating losses to their shareholders, and the capital positions of some member banks could become vulnerable.
Former US Treasury Secretary Lawrence Summers said last month's US employment situation showed that the Federal Reserve's interest rate hike was not working as it had in the past and instead increased the risk of a hard landing for the US economy.
Mr Summers said the risk of a hard landing could "look a bit greater" as job growth accelerates. Interest rates may no longer be the tool the U.S. used to guide the economy, which means they will have to be more volatile than in the past when the economy needs to cool down. Summers also warned that given the current sell-off in the bond market and rising valuations in many markets, including private equity, the U.S. economy is sitting on more dry firewood than ever before.
Albert Edwards, a prominent "big short" analyst at Societe Generale, also warned sharply: "The current resilience of US stocks in the face of rising bond yields reminds me of 1987, when US stocks were eventually brought down by the bond market." Analysts at Barclays have even said that only a collapse in the US stock market would save the bond market.
Analysts at Goldman Sachs and jpmorgan Chase have warned of a financial crisis as interest rates continue to rise.
However, once the debt crisis caused by the bad habit of the US government "live beyond their means" breaks out, it will be the global financial market that takes over.
