Burst Bubble Walking
Doug Nolan
Ten-year Treasury yields fell 16 bps this week, reversing about a third of last week’s spike.
MBS yields dropped 19 bps after last week’s 56 bps surge.
The U.S. Dollar Index declined 0.9%, adding to last week’s 2.8% drop.
From the standpoint of two primary markets suffering from a problematic waning of confidence, the week wasn’t much for relieving concerns.
As for Credit, the jury is also out.
April 14 – Financial Times (Eric Platt and Will Schmitt):
“America’s risky corporate borrowers have been shut out of the bond market since Donald Trump’s tariff blitz, in a freeze that is reverberating across Wall Street and which threatens a tentative rebound in dealmaking.
Lowly rated companies have failed to sell any debt in the $1.4tn US high-yield bond market since the president unleashed market turmoil and raised fears of a US recession with the wave of tariffs he announced earlier this month.
The freezing of the junk bond market threatens to hit private equity groups that frequently rely on it to help fund their takeovers.
It also raises the risk for banks that provide short-term loans for such deals before buyout firms then secure longer-term financing...
‘Everything has been on hold,’ said Bob Kricheff, the head of multi-asset credit at… Shenkman Capital Management.
‘Nobody is trying to price a deal in this environment.’”
April 17 – Bloomberg (Caleb Mutua):
“The US leveraged-loan market’s streak without a deal launch has reached record levels as tariff volatility crimped activity this month across primary credit markets…
Wednesday marked the 14th consecutive session without a new loan, the longest no-launch streak since Bloomberg started to compile the data in 2013…”
April 17 – Bloomberg (Jeannine Amodeo, Aaron Weinman and Gowri Gurumurthy):
“Wall Street banks are stuck with $2.35 billion in debt for the buyout of Patterson Cos., the second time lenders have been left on the hook for a big financing package since the Trump administration triggered a global trade war.”
The junk bond market opened for LNG developer Venture Global to price an upsized $2.5 billion deal, the first issuance in two weeks.
Junk yields (Bloomberg High Yield) dropped 38 bps to 8.19%, having now retraced less than half the spike from the 7.62% yield on April 2nd.
Junk yields ended February at 7.15%.
After widening 119 bps in the four sessions ended April 8th to 453 bps, high yield spreads have narrowed 55 bps to end the week at 398 bps.
Leveraged loan prices recovered 36 bps to 95.11 – after sinking 162 bps over the previous two weeks.
High yield CDS declined six this week to 424 bps – after beginning the month at 375 bps (292bps on February 19th).
April 15 – Financial Times (Harriet Clarfelt):
“A cornerstone of demand in the $1.4tn US junk loan market is under pressure to sell very risky debt…
Collateralised loan obligation vehicles, which own roughly two-thirds of US riskier corporate loans, may need to slash exposure to weaker borrowers most vulnerable to tariffs and recession because of the potential threat of rating downgrades…
The heightened pressure on CLOs is the latest sign of how fears that Trump’s tariffs could sharply slow US growth are rippling through the corporate debt market...
‘Whether it’s a recession, a mild recession, a slowdown in growth — at the minimum, we’re going to have a slowdown,’ said Roberta Goss, head of Pretium’s bank loan and CLO platform.
‘That will have implications across the credit markets — and in leveraged finance, that’s going to result in elevated defaults and elevated downgrades over the course of the next year.’”
There is little so far that indicates Credit is out of the woods.
While well off panic levels, unease overhangs the stock market.
The VIX index declined 7.9 to 29.7, still up significantly from the 21.5 on July 2nd.
Stocks were making some headway until Thursday’s 2.2% drop (S&P500).
Much of the decline came after Chair Powell began his presentation at the Economic Club of Chicago.
Below are excerpts from his opening remarks and discussion with University of Chicago professor and former Governor of the Reserve Bank of India, Raghuram Rajan.
As one of the world’s emminent central bankers, Dr. Rajan was the perfect moderator at a most opportune juncture for a chat with the Fed Chair.
Chair Powell, presenting at the Economic Club of Chicago, April 16, 2024:
“Looking forward, the new Administration is in the process of implementing substantial policy changes in four distinct areas: trade, immigration, fiscal policy, and regulation.
Those policies are still evolving, and their effects on the economy remain highly uncertain.
As we learn more, we will continue to update our assessment.
The level of the tariff increases announced so far is significantly larger than anticipated.
The same is likely to be true of the economic effects, which will include higher inflation and slower growth.
Both survey- and market-based measures of near-term inflation expectations have moved up significantly, with survey participants pointing to tariffs.”
Chair Powell:
“I mentioned in my remarks, [the administration] is implementing significant policy changes, and particularly trade now is the focus.
And the effects of that are likely to move us away from our goals.
So, unemployment is likely to go up as the economy slows, in all likelihood, and inflation is likely to go up as tariffs find their way.
And some part of those tariffs come to be paid by the public.
So that’s the strong likelihood.
And my hope is that we’ll get through this and get back.
Look, we’re always going to be aiming for maximum employment and price stability.
That’s what we do.
I do think we’ll be moving away from those goals probably for the balance of this year - or at least not making any progress.
And then we’ll resume that progress as we can.”
Raghuram Rajan, University of Chicago:
“What’s your sense about the effects of tariffs on inflation?
What would make them more persistent?
And what would make them have effects on growth?”
Chair Powell:
“In a kind of simple starting point is a tariff comes in that gets passed along in prices and raises inflation.
But it’s just a one-time thing…
But that can happen in some circumstances, but it depends on a number of things which we don’t know yet.
And I would point to… three of them…
One is just the size of the effects.
And as I mentioned, the tariffs are larger than forecasters had expected, certainly larger than we expected even in our upside case…
The second one is how long does it take for the tariffs to have their effects on inflation?
To the extent it takes longer and longer, that raises the risks that the public will begin to experience higher inflation.
They’ll come to expect it, and companies will come to expect it, so that risks higher inflation.
And the third is… gotta keep inflation expectations well-anchored.
So, if we have those three things under control, that’s what it will take.
And, indeed, our role is to make sure that this will be a one-time increase in prices, and not something that turns into an ongoing inflation process.
That’s a big part of our job.”
“So, all of this is highly uncertain.
We’re thinking now really before the tariffs have their effects - how they might affect the economy.
We’re waiting really to see what the policies ultimately are, and then we can make a better assessment of what the economic effects will be.”
Raghuram Rajan:
“Now… we’re talking about the future.
You may be confronted in the not-so-distant future with both higher levels of unemployment, as well as potentially higher inflation.
And of course, the policies that each one requires could be different.
You’ve talked a little bit at the podium about how the Fed would see these two, and how it would address it.
Just give you a chance again to elaborate on that.”
Chair Powell:
“Right, so most of the time, when the economy is weak, inflation is low, and unemployment is high, and both of those call for lower interest rates to support activity, and vice versa.
So, most of the time, the two goals are not in tension, and they’re not really in tension now.
The labor market is still strong.
But the shock that we’re experiencing, the impulses we’re feeling are for higher unemployment and higher inflation.
And, you know, our tool only does one of those two things at the same time.
So, it’s a difficult place for central banks to be in in terms of what to do.”
“What we say is we will look at how far each of the two - how far the economy is from each of those two goals, and then we’ll ask, might there be different paces at which they would approach those goals?
We’ll look at those things and think about them, and we’ll no doubt be a very difficult judgment.
Again, we’re not – we’re not experiencing that now, but we could well be in that situation…”
Raghuram Rajan:
“How do you take such longer-term uncertainty into account in your policies?”
Chair Powell:
“What comes back very strongly, everyone will understand this: these are very fundamental policy changes in long held, in some cases, policies in the United States, and there’s not any real experience.
I mean, the Smoot-Hawley tariffs were actually not this large, and they were 95 years ago.
So, there isn’t a modern experience of how to think about this.
And businesses and households are saying in surveys that they are experiencing incredibly high uncertainty.”
“I mean, your question really is, what if the uncertainty remains high?
I think that’s a difficult environment.
I think people’s expected rates of return would have to be higher.
I think it would weigh on, to me, investment just in general.
If the United States were to become a jurisdiction where risks are just structurally higher going forward, that would make us less attractive as a jurisdiction.
We don’t know that at this point, but I think that would be the effect.”
Raghuram Rajan:
“Some people believe the Fed will intervene if the stock market plummets, the so-called Fed put.
Are they correct?”
Chair Powell:
“I’m going to say no, with an explanation.
So, what I think is going on in markets is markets are processing what’s going on.
And it’s really the policies, particularly trade policy.
And, really, the question is where’s that going to come in?
Where’s that going to land?
And we don’t know that yet.
And until we know that, you can’t really make informed assessments that would still be highly uncertain once you know what the policies are.
It’ll still highly uncertain what the economic effects will be.
So, markets are struggling with a lot of uncertainty, and that means volatility.
But having said that, markets are functioning.
Conditional on being in such a challenging situation, markets are doing what they’re supposed to do.
They’re orderly and they’re functioning just about as you would expect them to function.”
Clearly, there is some de-levering going on among hedge funds in levered trades and things like that.
It’s also, again, it’s the markets processing historically unique developments with great uncertainty.
And I think you’ll probably see continued volatility.
But I wouldn’t try to be definitive about exactly what’s causing that.
I will just say markets are orderly and they’re functioning kind of as you would expect them to in this time of high uncertainty.”
Raghuram Rajan:
“You mentioned amongst the issues you were focused on was the U.S. fiscal situation.
Well, clearly, U.S. sovereign debt continues to rise.
And what are your thoughts on the longer-term implications for interest rates and economic stability?
How much further can we go in terms of national debt before we cross a line that might be unsustainable in the long-term?
Chair Powell:
“U.S. federal debt is on an unsustainable path.
It’s not at an unsustainable level.
And no one really knows how much further we can go.
Other countries over time have gone much farther, but we’re now running very large deficits at full employment.
And this is a situation that we very much need to address.
Sooner or later, we’ll have to, and sooner is better than later.”
“In terms of my time working on these issues, it’s not the Fed’s issue.
But if you look at a pie chart of federal spending, the biggest parts and the parts that are growing are Medicare and Medicaid, Social Security, and now interest payments.
And so that’s really where the work has to be done - and are issues that can only be touched on a bipartisan basis.
Neither party can figure out what to do without both parties being at the table. So that’s critical.”
“All of this domestic discretionary spending, which is essentially where 100% of the conversation is, is small as a percentage of federal spending, and it’s already declining as a percentage of federal spending.
So, when people are focusing on cutting the domestic spending, they’re not actually working on the problem…
I just like to make that point because so much of the dialogue that the politicians offer is about domestic discretionary spending, which is not the issue.”
Chair Powell:
“I think our banking system is well-capitalized with liquidity and is quite resilient right now to the kinds of shocks that it may face.
I do believe that…
In terms of the non-bank financial sector, it’s grown enormously.
The provision of credit by non-banks has grown just really fast.
Most of it has been funded though with a private equity-like structure, where it’s limited partners who are signed up for 10 years…
They’re not depositors who can run…
To your point though, Raghu, this very fast-growing and now quite large ‘private credit’ part of the economy has not really been through a significant credit event or a significant.
It’s really grown since the pandemic.”
Chair Powell:
“Our independence is a matter of law.
Congress has in our statute: we’re not removed except for cause.
We serve very long terms, seemingly endless terms.
So we’re protected in the law.
Congress could change that law.
But I don’t think there’s any danger of that.
Fed independence has pretty broad support across both political parties - in both sides of the Hill.
So, I think that’s not a problem…
We’re never going to be influenced by any political pressure.
People can say whatever they want.
That’s fine.
That’s not a problem.
But we will do what we do strictly without consideration of political or any other extraneous factors.”
The Fed Chair left much to contemplate.
Rather than the typical “Balanced Powell,” he was uncharacteristically direct.
Pulling no punches, Powell sees the administration’s policies as creating extraordinary risk:
“I mean, the Smoot-Hawley tariffs were actually not this large, and they were 95 years ago.
So, there isn’t a modern experience of how to think about this.”
“Our role is to make sure that this will be a one-time increase in prices.”
The likely scenario would be one of higher inflation with lower growth (and higher unemployment).
This Fed’s two mandates will be in “tension” – “a challenging situation” - and the Federal Reserve doesn't really have a solution.
It was almost as if Powell was telling the administration, “You break it, you own it.”
Nervous markets instead want to hear something to be interpreted as, “If they break it, we’ll fix it.”
Powell’s message was that markets were functioning pretty well under the circumstances.
Powell:
“Markets are doing what they’re supposed to do.”
Markets: “We hate this, and we want your assurance that the Fed is ready to do what you’re supposed to do.”
It’s such a fascinating environment.
Recall that Fed Governor Powell was initially skeptical of QE, expressing concerns and only reluctantly supporting quantitative easing in 2012.
Believe it or not, I think Powell in his heart believes markets should stand on their own.
The pandemic crisis was unique, and the Fed recognizes the massive QE response unleashed inflationary forces that have proved difficult to contain.
Powell’s comments confirm the analysis that the Fed is poised to be slow with another round of market-supporting QE.
The President is none too pleased, saying Powell is “playing politics.”
And perhaps Powell (and the Fed more generally) believes it is left to the markets as the only counteracting force with the power to compel the administration to change course on dangerously misguided tariff policies.
Instead of coming to the markets defense, let the administration deal with market instability of the administration’s doing.
Tough medicine, but in the end better for everyone.
In the same vein, Direct Powell threw ice water on DOGE and the administration’s discretionary spending-cut focus.
“When people are focusing on cutting the domestic spending, they’re not actually working on the problem.”
“Neither party can figure out what to do without both parties being at the table.”
Perhaps in the back of Powell’s mind is the rational thought that only bond market discipline will force Washington to begin dealing with a debt problem at the cusp of spiraling out of control.
As is typical, recent deleveraging was halted by a policy response.
But instead of the Fed coming to the market’s defense, it was the administration’s 90-Day Tariff Pause.
Good enough for a squeeze and reversal of hedges, but I seriously doubt marginal tariff retreats will restart “risk on” and leveraged speculation.
Instead, fragile markets face ongoing risks and uncertainty, with Fed liquidity support unusually ambiguous.
I’m sticking with the analysis that the great Bubble has been pierced, with markets vulnerable to what will be a problematic second round of deleveraging.
Highly uncertain market liquidity prospects will continue to pressure the leveraged speculators.
April 17 – Reuters (Howard Schneider):
“U.S. President Donald Trump… launched a series of attacks against Federal Reserve Chair Jerome Powell, accusing the central bank chief of ‘playing politics’ by not cutting interest rates, asserting he had the power to evict Powell from his job ‘real fast,’ and looking forward to the day when Powell was gone.
Powell’s termination as Fed chair ‘cannot come fast enough’, the president said in morning comments posted to social media…
‘The Fed really owes it to the American people to get interest rates down.
That’s the only thing he’s good for,’ Trump said.
‘I am not happy with him.
If I want him out of there, he’ll be out real fast believe me.’”
Powell:
“We’re never going to be influenced by any political pressure.
People can say whatever they want.
That’s fine.
That’s not a problem.
But we will do what we do strictly without consideration of political or any other extraneous factors.”
Markets are too fragile right now for this fight.
But can the President control his anger?
Powell is clearly not backing down – let alone pandering.
And President Trump seems unusually agitated.
His new tariff regime is a mess.
China is anything but backing down, with perhaps the administration beginning to realize this trade war game of chicken is one high-risk gamble.
They also have potential big issues with their game of chicken with Iran.
“Trump Ready to “Move On” From Ukraine Peace Talks If No Progress.”
“US Open to Recognizing Crimea as Russian in Ukraine Deal.”
CNN’s Jim Sciutto (April 18, 2025):
“If the Trump administration walks away, not just from these peace talks, but from Ukraine - it washes its hands of the war and ceases U.S. military support for Ukraine.
What happens then?
Can Ukraine, on its own and with European support, keep fighting?”
Retired General Wesley Clark:
“I think Ukraine has to keep fighting.
But I don’t think it’s likely to be very successful in the long-term because of [Russia’s] overpowering manpower strength - plus China, Iran, North Korea providing assistance.
And I’m already hearing that the administration is not only preparing to walk away - but prepared to put pressure on our allies not to support Ukraine.
And possibly by using tariffs as leverage against our allies not to support Ukraine.
It’s a horrible negotiating strategy.
We’ve made one concession after another to Moscow, and we’ve never gotten anything for it.
And these poor people in Ukraine are fighting for the very values that we Americans hold dear.
It is just inconceivable.”
I’ll assume it’s a false rumor that the administration is considering using tariff policy to force the European to withdraw of Ukraine support.
That would be a new low that would provoke an intense – and potentially destabilizing - response.
The administration has instigated too many conflicts – none going well.
And I worry about the President’s temperament and how he might react to myriad materializing challenges to his breakneck pursuit of unchecked power – at home and abroad.
If he lashes out, it seems Powell would provide the easiest target.
With markets fragile and vulnerable to deleveraging’s next phase, how quick might the Powell Fed come to the markets' defense with the Chair under ruthless attack?
Troubling times.
April 18 – Associated Press (Bernard Condon):
“Among the threats tariffs pose to the U.S. economy, none may be as strange as the sell-off in the dollar.
Currencies rise and fall all the time because of inflation fears, central bank moves and other factors.
But economists worry that the recent drop in the dollar is so dramatic that it reflects something more ominous as President Donald Trump tries to reshape global trade: a loss of confidence in the U.S…
‘Global trust and reliance on the dollar was built up over a half century or more,’ says University of California, Berkeley, economist Barry Eichengreen.
‘But it can be lost in the blink of an eye.’”
From Thursday’s Tactical Short Quarterly Call, "Decades of Inflation Home to Roost."
I’ll begin how I ended recent calls.
I so hope my analysis is wrong, and this is said with deepest sincerity.
I’ve analyzed many bubbles.
In particular, I can point to the 1997 “Asian Tiger” bubble collapse; 1998, with Long-Term Capital Management and Russia collapses; and the mortgage finance bubble collapse in 2008.
In each case, my analysis pointed to quite problematic bubble excess.
And in each collapse, things proved worse than what I had earlier considered a worst-case scenario.
I see evidence suggesting history’s greatest bubble has been pierced.
This is not the first time I’ve harbored such thoughts.
I’ve intensely monitored this multi-decade bubble since the early nineties.
I thought the bubble had burst with the collapse of the Internet and technology stocks in 2000/2001.
I reversed course in early 2002 with my warnings of an unfolding mortgage finance bubble.
I was pretty convinced the bubble had burst in Q4 2008.
I reversed course in March 2009, warning of an unfolding global government finance bubble.
Then, it looked like the bubble had finally burst with the pandemic crisis in March 2020, but it quickly became clear that egregious monetary and fiscal stimulus had triggered “blow off” bubble excess.
To be sure, reckless monetary inflation will never resolve bubbles.
It ensures they inflate to only more precarious extremes.
Let me explain why I don’t expect to reverse this call for the bubble’s demise.
I’ve argued for years now that the global government finance bubble was the “granddaddy of all bubbles.”
Bubble dynamics had finally directed subversive forces to the heart – the bedrock of global finance – to trusted sovereign debt and central bank credit.
With momentous consequences, bubble dynamics seized control of perceived safe and liquid “money-like” credit instruments that are subject to insatiable demand.
I’ve argued the government finance bubble is the end of the road.
Previous burst bubbles spawned bigger bubbles necessary for system reflation – collapsing telecom debt and junk bonds were supplanted by a much bigger boom in mortgage credit.
The mortgage finance bubble collapse unleashed a historic expansion of government debt and central bank liabilities.
However, there is today no fledgling colossal bubble waiting in the wings to take bubble inflation to even greater extremes.
And while the inflation of government debt and central bank balance sheets is certain to continue, the trajectory of over-issuance increasingly risks a loss of confidence.
I believe markets – notably sovereign bond markets - have begun to signal an evolving crisis of confidence – one that even risks a catastrophic loss of faith in the foundation of global finance.
Last week was extraordinary.
A deeply systemic global deleveraging was unfolding – with instability and acute stress slamming markets worldwide.
Yet the typical flight to Safe Haven Treasuries and the U.S. dollar was nowhere to be seen.
Indeed, Treasury yields spiked 50 bps – the largest weekly move since October 2001.
The dollar sank 2.8%.
Understandably, such confounding market developments sparked anxiety and debate.
Was the highly levered Treasury “basis trade” unwinding?
Were foreigners backing away from U.S. financial assets?
Could the Chinese be selling Treasuries as part of a trade war counterattack?
Did last week mark a momentous infection point in the era of the U.S. as the reliable anchor of global finance?
Were markets perhaps even signaling the undoing of U.S. “exorbitant privilege” and “American exceptionalism”?
It’s difficult to believe stocks hit all-time highs less than two months ago.
So much has changed – as if the world is being turned upside down.
We live in a critical period in history.
For starters, we’re witnessing the transition from a multi-decade boom cycle to a new cycle of utmost uncertainty.
Systems are in the throes of monumental transformational change, instability, turbulence, and uncertainty.
I chose the title “Decades of Inflationism Home to Roost” for today’s call, intending to expand on analysis I hope provides a little clarity to developments in the process of dismantling conventional wisdom.
When I took my first investment management position at a hedge fund in 1990, total U.S. non-financial debt was $10 TN, with outstanding Treasury securities at $2.2 TN.
The Fed’s balance sheet came in at $315 billion – about Elon Musk’s current net worth.
Fast-forward to the end of 2024.
Treasury securities have reached $28 TN; total non-financial debt $77 TN; and the Fed’s balance sheet $6.8 TN.
For decades, Federal Reserve officials, the economics community, and Wall Street all trumpeted the exceptional age of price stability.
They glorified an enlightened Federal Reserve that had slayed the inflation dragon and achieved price stability.
But it was deeply flawed analysis.
Recent decades have experienced historic credit inflation – monetary inflation with far-reaching consequences.
From my earliest Credit Bubble Bulletins back in 1999, I’ve tried to highlight all aspects of what for centuries was labeled “inflationism”.
Since my 1990 introduction, I have had deep appreciation for Austrian economics, especially its focus on the distorting effects credit inflation has on price structures, financial and economic structural development, and society more generally.
Importantly, credit expansions have myriad inflationary impacts - higher consumer prices being only one.
There are effects on asset prices and speculation, along with distortions in investment decisions, resource allocation, and economic structure.
The great German economist Kurk Richebacher was prescient when he repeatedly warned that asset inflation and bubbles were much more dangerous than rising consumer prices.
Credit inflation and asset bubbles fuel over-consumption, trade deficits, and currency devaluation.
The deleterious effects of deranged credit and inflationism include inequality, deep structural maladjustment, and an insecure, distrustful, and resentful society.
I believe the rise of Donald Trump and the populist MAGA movement is the consequence of decades of monetary mismanagement and pernicious inflationism.
President Trump is such a divisive figure.
In a CBB after the election, I wrote that half the country believes “nation saved” – the other half, “nation doomed”.
No hyperbole there.
Families, organizations, and communities are split, the country is spilt - along with the world.
It’s impossible to analyze the current environment without an emphasis on one of history’s most powerful individuals and his new administration.
So, if you disagree with my analysis – you see it as uninformed, politically ignorant – if you believe I suffer from TDS – “Trump derangement syndrome” – I understand.
I get emails saying all of that and worse every week.
I hope we can agree to disagree and focus on analyzing today’s precarious environment.
Not only is the Trump phenomenon a product of inflationism, I believe the President’s policy course has pierced history’s greatest bubble.
Bubble collapse was inevitable.
So, I won’t hold him responsible for decades of bubble excess.
He’ll share blame with many for the post-bubble environment.
But I certainly fear his policies will greatly exacerbate social, political, and geopolitical instability.
I’ve long feared the social and geopolitical consequences of decades of inflationism and bubble excess.
Bubbles are, after all, at their core mechanisms of wealth redistribution and destruction.
Corrosive inequality has become such a critical societal and political issue – at home and abroad.
For the most part, the wealth destruction nature of bubbles remains masked so long as bubbles inflate.
And with the great bubble now pierced, the specter of epic waste and structural maladjustment will begin to be revealed.
Society is already insecure, fractured, and bitter.
Trust in our institutions has sunk to alarming depths.
This also a global phenomenon.
Little wonder this is the era of the “strongman” ruler, with populations gravitating to persuasive individuals championing anti-establishment populist agendas with the promise of security, retribution, and forceful change.
Today, half the country is certain Donald Trump is the right person at the right time - the other half convinced he’s the wrong person at the wrong time.
I identify with the latter.
Especially as the great bubble culminated in crazy excess, extending into a fourth decade, my concerns for post-bubble societal and geopolitical instability only deepened.
An already deeply polarized society couldn’t be more poorly situated for the bursting bubble.
It’s become a tinderbox – and it’s difficult to envisage a President with a greater capacity to inflame.
I believe this unfolding bursting bubble, with dreadful effects on markets and the economy, will create a precarious backdrop for the administration’s culture war fixation.
I’ve always believed that holding society together post bubble would present a major challenge of paramount importance.
These days, I have serious worries about scenarios that previously seemed “lunatic fringe.”
The consequences of decades of inflationism could be even more dangerous from a geopolitical perspective.
I’ll repeat a general framework I’ve shared previously that I believe helps explain the rapidly deteriorating global environment – what is shaping up to be a breakdown of the existing world order: Bubbles are mechanisms of wealth redistribution and destruction – with detrimental consequences for social and geopolitical stability.
Boom periods engender perceptions of an expanding global pie.
Cooperation, integration, and alliances are viewed as mutually beneficial.
But late in the cycle, perceptions shift.
Many see the pie stagnant or shrinking.
A zero-sum game mentality dominates.
Insecurity, animosity, disintegration, fraught alliances, and conflict take hold.
From a geopolitical perspective, President Trump simply could not be more polarizing.
It’s like the great disruptor is taking a sledgehammer to the brittle global order.
And it’s alarming to see such fracturing, animus, and conflict heading right into deflating bubbles.
Certainly, an unstable and rupturing world - and faltering bubbles - are not coincidental.
Donald Trump has been lamenting trade deficits for 35 years.
I haven’t been a fan myself.
But I can’t imagine a more perilous juncture to experiment with the most disruptive tariff regime in a century.
Markets and economies are too fragile - fraught global relationships and alliances too frail.
The President will wield his phenomenal power and coerce trade concessions.
But will it prove a Pyrrhic victory?
If my bursting bubble analysis is correct, a focus on bolstering our nation’s security and well-being would emphasize strengthening relationships with friends and broadening our alliances.
We’ll need all of them.
The unfolding trade war with China is alarming.
Hopefully cooler heads prevail.
Perhaps President Trump will make more concessions.
But there is clearly potential for this war to spiral out of control – during a precarious juncture for such a fight.
Chinese officials have stated they’re ready to “fight to the end.”
I don’t think they’re bluffing.
They’ve been preparing for this scenario for months, if not years.
The President and his team, along with most analysts, believe the U.S. goes into this confrontation in a much stronger position than China.
China is suffering from a real estate collapse, stagnation, and fragile finance, while most assume markets and the economy in the U.S. are structurally robust.
Conventional analysis fails to recognize our system’s acute bubble fragilities.
Beijing likely comprehends U.S. vulnerabilities more adeptly than Washington.
I’ve written that President Trump’s tariff policies have pushed our system to the edge - and pondered whether Xi Jinping will resist the urge to provide a nudge.
There is surely no greater priority for Xi Jinping than to see the downfall of so-called U.S. “exorbitant privilege.”
This competitive advantage has for decades provided incredible benefits to China’s global superpower adversary.
We enjoy the extraordinary benefits of having the world’s safe haven Treasury market - and the most robust financial markets generally - coupled with the globe’s dependable reserve currency.
Now, President Trump has unwittingly exposed U.S. bubble fragility.
This vulnerability, combined with reckless policymaking, puts U.S. markets, the American economy, and the dollar at great risk.
Today, our financial system and economy are too fragile for misguided and haphazard risk-taking.
The U.S. and China each have a tremendous amount to lose from a trade war.
But the administration and most analysts don’t appreciate that Beijing has much to gain.
This trade war presents Xi Jinping with a unique opportunity in history.
A global financial crisis would create challenges and risks.
But blame would be directly cast on Donald Trump.
The Chinese population is rallying around Xi and the communist party, a timely deflection of blame away from Beijing’s own policy blunders and mismanagement.
A Trump global crisis would also afford China a great opportunity to expand its close circle, its alliances, and its global influence.
In the battle for global supremacy, one superpower would be expanding alliances and relationships, with the other at risk of being discredited and in retreat.
Beijing might also calculate that a U.S. in disarray would be less compelled to exert influence throughout Asia - and less likely to come to Taiwan’s defense.
A world with a wounded U.S. would be a playground for China and Russia.
And for Beijing and Moscow, a world without U.S. “exorbitant privilege” would be a dream at long last coming true.
It’s rational for Xi Jinping to accept short-term pain for the prospect of a level playing field that ensures China’s destiny as the supreme global power unencumbered by U.S. repression.
Might Beijing do a cold, strategic calculation - and go for the jugular?
The stakes couldn’t be higher.
Secretary of Defense Hegseth recently traveled to meet with Asian allies, vowing to strengthen U.S. resolve against China’s aggression.
Days later, China launched major live-fire military exercises that simulated a blockade around Taiwan – while issuing stern warnings directed at the U.S.
Last week’s market behavior was fascinating, including a remarkable one-day rally following the tariff pause.
At least for a day, markets dismissed President Trump’s China trade war escalation.
But as yields spiked higher through the end of the week, concern shifted to whether China might be trimming its large Treasury holdings.
The administration – especially Treasury Secretary Bessent – keeps repeating what a big mistake China is making – that they’re playing with a weak hand – “a pair of twos”, as described by Bessent.
For an administration that has specifically stated the objective of lowering long-term market yields, to have its trade war adversary sitting on an estimated $760 billion of Treasuries is not a “weak hand”.
There are big problems if these two adversaries refuse to back down.
The world is in the throes of a major deleveraging – a dynamic that could easily spiral out of control.
Just last week, global markets were at the cusp of seizing up.
The leveraged speculators were caught on the wrong side of dislocating markets, forced to liquidate stocks, Treasuries, sovereign and corporate debt, and commodities.
Acute stress developed across derivatives markets, notably in interest-rate and currency “swaps” markets integral to hedging strategies.
Deleveraging is a really big deal.
Secretary Bessent last week called it “normal deleveraging.”
And there’s some justification for complacency.
There were flareups over recent years soon forgotten – the October 2022 Liz Truss UK gilts episode; the March 2023 bank run mini-crisis; and then last August’s yen “carry trade” instability.
In all cases, quick policy responses reversed nascent deleveraging – and in no time it was right back to leveraging and speculating business as usual.
The last sustained deleveraging erupted with the March 2020 pandemic panic.
Many of the indicators I closely monitor – CDS prices, credit spreads, risk premiums, derivatives pricing, and such – recently posted their biggest moves since 2020.
This is serious and won’t be resolved with tariff concessions.
Once deleveraging starts, the liquidation of positions and the unwind of speculative credit drive lower market prices and waning liquidity - a dynamic that spurs risk aversion and the impetus to reduce speculative leverage.
When deleveraging is quickly reversed, the impact of waning liquidity, contagion, and risk aversion is thwarted before momentum is gained.
But deleveraging attained powerful momentum last week on a systemic basis – across global markets.
An ebb and flow would be typical, but it’s likely too late to get the genie back in the bottle.
A meaningful tightening of financial conditions has developed.
Corporate debt issuance has slowed to a trickle.
Importantly, junk bond and leveraged loan prices came under significant pressure.
This needs to be reversed quickly.
Our system is now years into a major “subprime” lending boom, exemplified by the imprudent ballooning of so-called “private credit.”
High risk lending is always a seductively rewarding endeavor during boom times – boundless eager borrowers willing to pay exorbitant rates to finance all sorts of things.
And so long as credit is readily available, a lot of overstretched and crooked borrowers will stay current on their obligations – borrowing from Peter to pay Paul – borrowing against inflated asset prices for fun and pleasure.
But let there be no doubt, this is a game of musical chairs – a Ponzi scheme.
When finance tightens and borrowers lose access to new borrowings, the party ends abruptly and the downside of the credit cycle takes on a life of its own.
Markets are signaling tighter finance and rapidly escalating credit concerns.
There was an article a couple weeks back that highlighted the ranking of communities by the highest average household credit card balances.
No surprise, California dominated the top slots.
At number one, average households in Santa Clarita were carrying $22,753 on their credit cards.
Chula Vista placed second at $20,567.
These are wealthier communities, so I have to assume that stomaching such expensive debt was part of a strategy of plowing cash into the booming stock market.
This illustrates a fundamental vulnerability that is not well appreciated by mainstream analysts.
Households have never been as exposed to stocks.
A bursting equities market bubble will come with negative wealth effects and more cautious consumers.
It will also expose extraordinarily problematic over-indebtedness – even for higher income households.
The marketplace has started to back away from high-risk consumer credit – which will force companies to tighten credit limits and lending more generally.
From my Austrian economics roots, I often refer to the U.S. as a “bubble economy”.
Bubble economies appear sound – even robust – so long as financial conditions remain loose, credit growth strong, asset prices inflated, and spending and investment elevated.
However, problems fester below the surface.
Vulnerability is revealed as conditions tighten.
Well, conditions have tightened significantly.
It is central to my bubble thesis that uneconomic and negative cash flow enterprises have proliferated throughout this most protracted period of ultra-easy “money”.
I believe years of deranged finance have come home to roost.
Unless conditions loosen quickly and debt markets get back open for risky borrowers, we’ll see a ramp up of layoffs and business failures.
There’s already been a collapse in small business confidence.
When financial conditions remained extraordinarily loose, my analysis pointed to a tenuous continuation of “bubble economy” dynamics.
Now, I believe a downturn has begun, with the potential to stun conventional analysts with its depth and duration.
But don’t listen to me – hear what markets have to say.
I’ve already mentioned last week’s extraordinary spike in Treasury yields.
Benchmark mortgage-backed securities yields surged 56 bps last week to 5.91%, the largest jump since 2020.
Junk bond yields were up 96 bps in seven sessions to 8.58%, trading to the high since October 2023.
Junk bond yield spreads to Treasuries widened 119 bps in four sessions.
Leveraged loan prices traded to lows since July 2023.
CDS prices had their biggest moves since the March 2020 crisis – investment-grade, high yield, and bank CDS prices.
At Wednesday’s close, muni (AAA) yields were up 89 bps in three sessions, before ending the week 66 bps higher.
Importantly, such dramatic yield spikes are indicative of markets seizing up.
Debt markets – including leveraged lending - were essentially shut down.
Worse yet, acute debt market stress was a global phenomenon.
Last week, 10-year yields surged 57 bps in Colombia, 49 bps in Turkey, 48 bps in the Philippines and Mexico, and 46 bps in Indonesia.
EM currency losses, especially versus the surging Japanese yen, meant speculator pain and “carry trade” deleveraging.
A Bloomberg headline: “Emerging Stocks Sink Most Since 2008 as Tariff Turmoil Deepens.”
Down 13%, stocks in Hong Kong suffered their worst session since 1997.
Major stock index losses included Taiwan down 9.7%, Japan 7.8%, South Korea 5.6%, and China 7.0%.
I view the past couple weeks in the context of an expected arduous and protracted deleveraging period.
Deleveraging last week went to the precipice – and recoiled after the 90-day tariff pause.
This episode provided important thesis confirmation.
Highly over-levered systems at home and abroad exposed their fragility.
From experience, such market dynamics tend to be unpredictable.
But I am confident that the leveraged speculating community and market systems more generally have suffered impairment.
Leveraged speculation over years ballooned to become THE key marginal source of liquidity throughout global markets – and this key source of liquidity is now unsteady and weakening.
Confidence has been shaken – confidence in policymaking, market structure, and in the future.
While timing is always uncertain, mounting fragility raises the odds that the next phase of deleveraging turns highly destabilizing.
Last week, we also learned that the Treasury market and dollar face serious issues.
In past crises, so-called U.S. “exorbitant privilege” provided critical system ballast.
Now, important new market dynamics are afoot.
In particular, the Treasury market now seemingly creates a key source of potential instability.
Concerns - including Chinese selling and even a replay of a Liz Truss-style crisis of confidence - have the potential to destabilize the most important market in the world.
Count me skeptical that Congress will rein in deficit spending.
It will be difficult, if not impossible, to offset anticipated tax cuts with a combination of spending reductions and tariff revenues.
I expect tariff receipts to come in much below the numbers bandied about by administration officials.
I also fear that dynamics associated with deflating bubbles will see a problematic increase in countercyclical federal spending, coupled with weak receipts from personal income, corporate and capital gains taxes.
Prospects for inflation are both troubling and highly uncertain.
Global market instability and deleveraging have put pressure on crude oil and some of the more industrial commodities.
A seizing up of global markets has the potential to unleash the forces of economic depression and deflation.
But beyond the shorter-run, inflation prospects are troubling.
Globalization has been a powerful force for lower goods prices.
I’m all for rebuilding our industrial base, but for many things, the U.S. would be a high-cost producer.
And, at the minimum, the unfolding trade war with China will accelerate decoupling between the world’s great consumer and producer economies, a dynamic conducive to supply-chain problems and ongoing inflationary pressures.
As crisis dynamics gain momentum, I see no alternative for the Fed and global central bank community than to aggressively expand their balance sheets to accommodate speculative deleveraging and counteract acute systemic stresses.
The administration’s new tariff regime will be an inflationary shock, though the intensity and duration are unclear.
There is the clear possibility that the Fed is forced into another aggressive round of QE despite elevated inflation risk.
A future scenario that has for years occupied my thinking could now turn into reality.
How might the Treasury market react in an environment of massive issuance, elevated inflation risk, and aggressive Federal Reserve “money printing”?
I never contemplated that such a scenario would also include pursuit of the most extreme tariff regime, fraught relations with our allies, a potentially perilous trade war with China, and a trillion dollar plus highly levered “basis trade.”
For years, I’ve expounded my analytical framework and bubble thesis, warning of dire consequences.
I appreciate that it has often seemed like stubbornly pessimistic analytical musings, especially with markets rising inexorably higher.
Well, my overarching message is that bursting bubble risk is reality today.
I purposely titled today’s call “Decades of Inflation Home to Roost”.
Not “coming home” – it’s here now, knocking on the door, if you will.
Reckless monetary inflation and loose financial conditions were never a solution.
From my perspective, our goal is to look back at this period and feel that we did our best to prepare for unprecedented uncertainty and turmoil.
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