BONDS BEYOND BESSENT`S CONTROL / MACLEOD FINANCE

Bonds Beyond Bessent’s control

Treasury Secretary Bessent tried to beat Mr Market by suppressing bond yields. He should know that it can’t be done, and it is being proved not possible yet again.

Alasdair Macleod

In recent days, the yield on the 10-year US treasury note has broken out above its three-year consolidation phase, confirmed by its short- and longer-term moving averages in bullish sequence: that is to say, bearish for the price. 

This is despite Bessent’s intervention at the 4.7% yield level on the 10-year note.

While the yield has yet to exceed the 5% level, it appears to be a hurdle which will be easily overcome because these chart formations, commonly termed pennants after their shape, tend to mark the half-way point in an ongoing trend. 

This is best illustrated in the chart of the long bond, which is already embarking on the next leg higher. 

This is next:

Note that this chart is on a logarithmic value scale, illustrating how the percentage move of 250% from the 1.9% low to 5% could run to well over 10% from the breakout over the same brief timescale. 

The fundamental justification is a combination of the Hormuz and Bab el-Mandab blockades, the debt trap sprung on US government finances, the end of the petrodollar leading to surplus dollar balances in foreign hands, and the global loss of confidence in the dollar from an American geopolitical defeat.

This move to far higher bond yields will almost certainly trigger massive selling of the dollar, a point addressed later in this article. 

It is a racing certainty that the Secretary Bessent will order the suspension of trading in bonds and equities, as his predecessor William MacAdoo did in July 2014. 

That time, Wall Street remained shut until the following December. 

A prolonged market closure today to stop foreign and domestic selling is a real possibility. 

Don’t get trapped, because if it happens, markets will open considerably lower and investors will face large losses on their investments and on the currency as well.

I shall write about this possibility in a future post.

US fiscal policy is in crisis

In September 1992, Bessent was an intern for George Soros when the British government tried to beat the market by supporting sterling within the ERM snake. 

With some help from Soros and others, Prime Minister John Major and his Chancellor Norman Lamont were forced to back down and sterling immediately fell 15% against the German mark to which it had been pegged.

Bessent is now in the position of Norman Lamont, who some say was forced against his judgement to follow the orders of his prime minister. 

Today, should be an acute case of déjà vu for Bessent.

This time, Bessent was trying to suppress his borrowing costs by buying long maturity bonds in order to escape a debt trap, brought on by his president’s frankly senseless and unnecessary attack on Iran. 

It is leading to a complete failure of US foreign policy in the widest geopolitical terms, an inescapable slump in global trade, and substantial foreign liquidation of dollars in foreign hands. 

The consequences are the triggering of debt traps for the dollar and other G7 currencies; particularly Japan’s yen, Britain’s pound, and the EU’s euro. 

There is everything at stake.

What is a debt trap?

Anyone who has borrowed money will tell you that you must meet the interest payments to stay out of trouble. 

And if interest rates rise, you must also be able to meet the extra cost. 

Failure to do so leads to Micawber’s misery, and probably bankruptcy. 

What is true for ordinary folk and businesses is also fundamentally true for governments.

Conventionally, government debt-to-GDP is used as a debt comparison. 

But to judge national creditworthiness, debt-to-GDP estimates should use the private sector tax base as the proper basis for assessing debt affordability, because debt interest must be covered by tax revenues. 

The chart below illustrates the position for the G7 member states adjusted for private sector tax bases to give a better perspective for assessing debt affordability. 

Bond risk is significantly higher than commonly thought due to higher debt ratios.

In the case of the US, government debt has recently crossed the $40 trillion mark, and interest payments have risen to about $1.25 trillion. 

And instead of debt to GDP of 125%, the US adjusted rate for the private sector which pays the taxes to pay the interest becomes 200%. 

Obviously, if an economy is no longer growing and tax revenue is declining, bond holders and investors will require greater risk premiums.

The next chart shows the history of growth in government revenues in recent years compared with the growth in outstanding debt to be financed:

There was significant volatility in revenues over the covid crisis, but by 2024 that had settled down. 

However, in 2026 — the fiscal year ending this month — debt is beginning to grow more rapidly than the revenue available to fund it. 

Mr Micawber and his warning about financial misery is beginning to be relevant, and you can see why Bessent should be panicking over funding difficulties. 

It is the fundamental reason for bond yields to start rising again. 

But the problem with an increase in interest rates is that it worsens the borrower’s debt difficulties: the higher they go the worse it gets. 

So, we can see how bond yields could soar even further, with each step rise worsening the situation and justifying further yield increases.

This is before the Hormuz debacle hits US corporations and consumers. 

The headline price of oil has been suppressed by drawdowns from US strategic reserves, which cannot supply much more without risking structural damage to underground storage. 

But people don’t use crude oil, they use diesel for nearly all land logistics, kerosine for jet fuel, and diesel-like fuel for ship bunkers. 

Separate them out, and they add up to substantial premiums over the cost of a barrel of oil. 

The shortages are designated acute with premiums at $70 per barrel compared with normal cracked spreads of $10—$20:

With the cracked components at a premium of nearly $70 over crude, that puts crude at closer to $140 rather than $90 for WTI and $94 for Brent currently. 

But that is not all. 

Missing from the Persian Gulf are other vital supplies including fertilisers, sulphuric acid, helium, etc. 

Making things even worse is China’s understandable decision to stop exporting fertilisers and sulphuric acid as well as other oil derivatives to protect her own supplies. 

And that’s before we consider other factors driving shortages, such as Ukraine’s successful drone attacks on Russia’s refining facilities causing Russia to cease her diesel exports, having been a major global supplier.

In addition, drought conditions in Europe have stunted cereal yields, and exports from Ukraine of wheat and other cereals have ceased due to their Black Sea ports being blockaded by Russia. 

Food prices are already heading higher. 

The chart below is of wheat:

Economic consequences for the US

Clearly, the blockades in the Persian Gulf are not going to be resolved soon and private sector activities are heading for an economic slump. 

Higher borrowing costs will cause overindebted businesses to fail, and the consequences of significantly higher mortgage rates will undermine property values. 

The equity market bubble will certainly collapse and putting it altogether, personal wealth will suffer greatly.

At the same time, government finances will face a combined hit of declining tax revenues and rising welfare costs. 

Lending risk to governments and their private sectors will surely increase almost exponentially, bringing forward the full horrors of a debt trap.

Central banks face a choice: do they just stand aside and watch the carnage unfold while attempting to preserve their currencies’ values? 

Or do they do what they can to support failing businesses, stop financial markets from collapsing, and bail their governments out?

There is little doubt that politics will demand bailouts, so their currencies will take the hit. 

It is too late for remedial action. 

Dumping a currency nearly always starts with foreign sellers. 

Onshore in the US, they have about $48 trillion tied up in investments and bank deposits:

In addition, there are a further $14 trillion in offshore eurobond markets, and according to a Bank for International Settlements 2022 survey, a further $82 trillion tied up in foreign exchange transactions at any one time. 

For an economy estimated to have a GDP of $32 trillion, this is a lot of footloose currency overhanging it.

So, what do foreign holders of dollars sell them for? 

The other G7 currencies are in a similar situation to the dollar. 

In collapsing financial markets, the remedy is usually to buy back into your currency of account, despite its outlook, and buy some gold. 

Additionally, stockpiles of needed commodities make sense for industrial entities.

But where are the buyers of dollars? 

They simply don’t exist in any scale, because US holdings of foreign financial assets tend to be denominated in dollars and not other currencies. 

The consequences for the dollar’s exchange rate in gold and real goods are likely to be catastrophic.

Therefore, we can assume that the fall in the dollar’s value measured in terms of real things is set to become precipitous. 

Led by the dollar, other fiat currencies are sure to follow. 

In the light of debt traps and their consequences, we can see why it is that the major fiat currencies are losing value at an accelerating rate measured in gold, which has no counterparty risk:

Getting out of credit and into real physical money has never been so urgent. 

As a footnote, there was a similar scare at the outbreak of WW1, when foreign selling of some $4 billion in US investments was feared when the banking system had only $1 billion in gold reserves. 

Treasury Secretary William MacAdoo addressed this fear by ordering the closure of the stock exchange on 31st July 2014, not reopening until that December. 

We can see this happening again.