BONDS TAKING CHARGE AND Q2 `26 Z.1 / CREDIT BUBBLE BULLETIN

Bonds Taking Charge and Q2 '26 Z.1

Doug Nolan

The global bond market rout this week showed signs of turning disorderly. 

Ten-year Treasury yields traded to 4.98% intraday Friday, within a basis point of a 19-year high from October 19, 2023. 

Ten-yield yields ended the week 18 bps higher at 4.97%. 

Two-year Treasury yields surged 26 bps to 4.63%, while benchmark MBS yields spiked 26 bps to 6.03% (yields up 39 bps in 10 sessions), the high back to January 2025. 

“Municipal Bond Yields Soar to Highest Since 2011 in Rout.”

The rates market ended the week pricing 2.0 hikes by yearend, up from the 1.35 at Monday’s close. 

CPI up 3.4% y-o-y and PPI 4.6% higher are a problem. 

University of Michigan one-year inflation expectations jumped a stronger-than-expected 0.6 during September to 4.6%.

Things were just as bad – for some even worse – overseas. 

French 10-year yields spiked 26 bps to 4.45% - the high back to August 2008. 

Italian yields rose 20 bps to 4.35% (3-yr high), while Greek yields jumped 22 bps to 4.22% (3-yr high). 

German yields gained 17 bps to 3.50% (high since August 2009). 

UK yields surged 21 bps to 5.34% - the high back to July 2007.

Australian 10-year yields jumped 17 bps to 5.37%, with New Zealand yields 24 bps higher at 5.02%. 

South Korean yields rose 14 bps to 4.52%.

EM bonds could not escape. 

Ten-year (dollar) yields jumped 23 bps in the Philippines (5.83%), 20 bps in Indonesia (5.88%), 20 bps in Turkey (7.42%), 18 bps in Chile (5.59%), 15 bps in Mexico (6.62%), and 14 bps in Colombia (7.08%). 

Local currency yields surged 22 bps in Colombia (12.51%), 19 bps in Mexico (9.44%), 18 bps in Slovakia (4.17%), 17 bps in Hungary (5.58%), and 16 bps in South Africa (8.88%).

With the yen rallying 1.7% this week, pressure is building in the beloved “carry trade” universe.

September 11 – New York Times (Adam Rasgon, Shuaib Almosawa, Saeed Al-Batati and Pranav Baskar): 

“The militia captured the island in the Bab al-Mandab Strait, a choke point for trade. 

Saudi Arabia also announced it had shut down a critical oil pipeline after a drone attack launched from Iraq. 

The Iranian-backed Houthi militia seized an island in a choke point of the Red Sea after days of fierce fighting, two Yemeni government officials said Friday, giving Iran and its allies sway over the two main routes for shipping oil out of the Middle East. 

The capture of Perim Island came as Saudi Arabia announced that it had shut down a critical oil pipeline, a day after Houthi forces swept into the strategic port city of Mokha in Yemen. 

Both were major setbacks for the Saudi kingdom, which exports most of its oil through the Red Sea. 

The kingdom’s foreign ministry said the pipeline was hit on Thursday by drones launched from Iraq.”

Bond markets recognize the likelihood of a prolonged conflict in the Middle East, with potentially dire inflation ramifications. 

Crude oil (WTI) surged 9.4% this week to surpass $100. 

Diesel prices jumped to $6 a gallon.

The Trump administration, facing potential war escalation through the midterms, appears increasingly desperate. 

The Treasury Secretary’s fading market credibility is visible to all.

September 10 – Financial Times (George Steer, Kate Duguid and Ian Smith): 

“Scott Bessent’s bid to steady the $32tn US government debt market has backfired, with investors warning that the Treasury secretary’s opening shot was too timid to halt a surge in yields and instead dented his credibility… 

The intervention has instead stirred fears that America — the anchor of global finance — is acting in a way more commonly associated with weaker borrowers. 

‘We can’t ignore the fact that there are emerging-market-type risks in some of the actions the US has been taking,’ said Ellen Zentner, chief economic strategist at Morgan Stanley Wealth Management. 

‘We typically haven’t seen interventionist policies coming out of the US. 

Or when we have, it has been a formal, institutionalised process.’”

September 9 – Financial Times (Emily Herbert, Ian Smith and Ramsay Hodgson): 

“US Treasury Secretary Scott Bessent has warned traders not to bet against the yen, saying ‘I am the house now’ following his recent intervention to support the Japanese currency. 

‘When we intervene with the Japanese yen, I have pretty good insight into what the Bank of Japan is going to do, what Japanese policymakers are going to do,’ Bessent said… 

‘I have asymmetric information. 

I am the house now,’ Bessent said. 

‘You can bet against me if you want.’”

September 11 – Bloomberg (Erica Yokoyama): 

“Japanese Finance Minister Satsuki Katayama said US Treasury Secretary Scott Bessent’s recent reference to himself as ‘the house’ sounded a little frightening when translated into Japanese, while saying she understood the expression reflected the secretary’s former role as a hedge-fund manager. 

Bessent described himself earlier this week as ‘the house,’ as he has access to ‘asymmetric information’ regarding the Bank of Japan’s next policy steps. 

‘Given the nuances of the Japanese language, it does sound a bit scary, doesn’t it?’ Katayama told reporters... 

Japanese media translated Bessent’s reference to the house as ‘domoto,’ a term associated with illegal gambling. 

The secretary clarified his ‘house’ remark on Thursday. 

‘Where I said I am the house, I didn’t challenge people to come to me,’ he said. 

‘I’m not saying ‘I am always right, don’t challenge me.’ 

But I am trying to say I have superior information and that I am trying to give the market good framing so that they don’t panic.’”

September 9 – Bloomberg (Enda Curran, Greg Ritchie, Michael MacKenzie and Vinícius Andrade): 

“Over and over again, Treasury Secretary Scott Bessent keeps warning investors that he’s going to burn them. 

Whether they’re bidding up the price of oil, pushing down the Japanese yen or, most importantly, driving up US Treasury yields, they’re making a big mistake, he insists, because he’s on the other side of the trade, armed with valuable information on government policy plans they don’t possess. 

In the jargon of game theory, it’s called asymmetric information, as the former hedge-fund trader is fond of pointing out. 

He’s uttered it publicly at least four times in the past three weeks alone, including Tuesday, when he dared currency traders to ‘bet against me if you want.’ 

They’re starting to — at least in the bond and oil markets…”

September 8 – Bloomberg (Yash Roy): 

“Treasury Secretary Scott Bessent said his move last month to expand a buyback program for older US government securities was aimed at quelling a ‘fever’ in the bond market. 

‘My job is to try to push things back towards equilibrium,’ Bessent said... 

‘I don’t believe that I can change the equilibrium price. 

But nothing’s ever in equilibrium… 

There was like this fever that was building… 

Having been in the financial markets, like when you’re speculating, you want to speed things up,’ he said, alluding to his career as a hedge fund executive.”

A feverish bond market is taking charge - and will surely have low tolerance for nonsense. 

The administration is tone deaf.

September 10 – Associated Press (Jonathan J. Cooper): 

“President Donald Trump pledged… to send every American adult $5,000 if Republicans retain control of the House and Senate in the midterm elections, an extraordinary gambit to reverse his party’s sagging fortunes in November. 

The dubious promise would most likely cost more than $1 trillion and require congressional approval, and would further exacerbate the country’s nearly $1.8 trillion annual budget deficit and concerns about inflation. 

‘If the Republicans win, you win with us and you get $5,000,’ Trump said... 

‘It will be called the Trump Dividend.’”

Less than two months until the midterms, a timeline of utmost significance in Tehran (and elsewhere). 

These days, the President’s bluster and threats fall on deaf ears – in Tehran, Beijing, Ottawa, Brussels, London and elsewhere, including Wall Street. 

Market sentiment is shifting from “the fix is in until the midterms” to something urgently needs to be fixed in this administration before the wheels come flying off. 

Bessent’s tough guy act may play well in the Oval Office, but it will not suffice in the unfolding market backdrop. 

And it’s difficult to envisage the President adopting the type of responsible behavior necessary to calm increasingly unstable financial markets. 

It’s going to be a wild couple of months.

Another fascinating Federal Reserve (Q2) Z.1 report – ongoing ballooning in Treasuries and Agency debt, “repo,” Wall Street assets and lending, money funds, securities, household assets and net worth…

Non-financial debt (NFD) expanded during Q2 at a seasonally-adjusted and annualized (SAAR) rate of $4.289 TN, down from Q1’s booming SAAR $4.851 TN – but up significantly from Q2 ‘25’s SAAR $2.682 TN – to a record $84.093 TN. 

NFD inflated $5.073 TN y-o-y, the strongest annual expansion excluding the pandemic (2020’s $6.778 TN).

Foreign U.S. borrowings increased $449 billion during Q2 (22% annualized) to a record $8.611 TN, second only to Q1 ’25 ($480bn), with one-year growth of $1.036 TN, or 13.7%. 

Foreign debt was up $2.063 TN, or 31.5% over two years.

Total Financial Sector borrowings rose $657 billion (9.7% annualized) to a record $27.662 TN – the strongest quarterly expansion in five years.

Outstanding Treasury Securities rose $237 billion during the quarter to a record $30.878 TN, the weakest expansion in a year. 

Still, Treasuries inflated $2.360 TN over four quarters, with two-year growth of $3.975 TN. 

Outstanding Treasuries rose $14.249 TN, or 86%, over 26 quarters and $26.385 TN, or almost six-fold, since 2007. 

The ratio of Treasuries-to-GDP ended Q2 at 95%, up from 2019’s 76%, 2007’s 31%, and 1999’s 33%.

Agency (MBS/bonds) Securities increased $201 billion (6.4% annualized) during Q2 (up from Q1’s $74bn) to a record $12.763 TN – the strongest quarterly expansion since Q1 ’23 (Silicon Valley Bank/bank run Crisis). 

At $43.641 TN, combined Treasury and Agency Securities ended June at 134% of GDP.

Government-Sponsored Enterprise (GSE) assets surged $176 billion during Q2 – the largest growth back to Q1 ’23 – to a record $9.869 TN. 

The FHLB banks expanded $78 billion to $802 billion, also the strongest since Q1 ’23.

Corporate Bonds expanded $307 billion (7.0% annualized) during the quarter to a record $17.705 TN – the strongest growth in five quarters. 

Corporate Bonds expanded $901 billion y-o-y, the largest one-year growth since Q3 ’24. 

Non-Financial corporate bonds increased $82 billion, with Financial Sector bonds up $108 billion during Q2. 

Broker/Dealers expanded bond borrowings by $51 billion – the strongest increase since Q3 ’24.

Total Debt Securities expanded $843 billion during Q2 to a record $67.338 TN, down from Q1’s $1.009 TN, while up from Q2 ‘25’s $504 billion. 

Total Securities expanded $3.863 TN over four quarters, second only to 2020’s record expansion ($6.227 TN) and above the five-year annual average of $3.00 TN.

Notably, Equities surged a record $17.644 TN during the quarter to an all-time high of $123.687 TN – with one-year growth of an incredible $25.448 TN, or 25.9%. 

For perspective, Equities’ Q2 expansion surpassed the annual record set last year ($16.355 TN). 

Equities ended June at record 353% of GDP, up from 2019’s 248%, and compared to previous cycle peaks, Q3 ‘07’s 188% and Q1 2000’s 210%.

Illuminating a key Bubble Dynamic, Total (Debt and Equities) Securities ended Q2 at a record $191.025 TN, or a record 588% of GDP. 

Previous cycle peaks had Total Securities at $54.761 TN, or 376% of GDP, during Q3 2007 and $35.713 TN, or 357% of GDP, for Q1 2000.

Playing second fiddle to booming securities markets, the banking system nonetheless posted another solid quarter. 

Bank Assets expanded $298 billion to a record $30.031 TN, slowing from exceptional Q1 growth ($585bn), but little changed from Q2 ’25. 

Total Loans expanded $291 billion, or 6.9% annualized, to a record $17.200 TN – with one-year growth of $1.018 TN (6.3%). 

This was double that $530 billion annual average over the past 16 years. 

Business loans expanded $165 billion, or 10.8% annualized, with one-year growth of $713 billion, or 12.9%. Mortgage loans expanded $70 billion (3.8% ann.) and Consumer Credit $53 billion (7.7% ann.)

Growth in Bank Debt Securities holdings slowed to $43 billion, posting small declines in both Treasury and Agency holdings. 

Meanwhile, holdings of Corporate Bonds rose $60 billion to a record $1.018 TN – the strongest expansion since Q1 ’21. 

On the liability side, Total Deposits expanded $245 billion to a record $22.421 TN, with one-year growth of $1.162 TN (5.5%). 

Repo Liabilities gained $58 billion to $822 billion.

The historic Broker/Dealer boom ran unabated during Q2, with total assets expanding a record $553 billion, or 33% annualized, to a record $7.242 TN. 

The Asset “Loans” jumped $167 billion, or 22% annualized, to a record $3.178 TN. 

One-year growth of $520 billion (19.6% ann.) was an annual record. 

It's worth noting that loans had never posted annual growth above $365 billion prior to 2025's record $488 billion. 

Debt Securities holdings declined $29 billion, led by a $54 billion drop in Treasuries.

For the most part, there’s little transparency to explain the surge in Broker/Dealer assets. 

Miscellaneous Assets jumped $441 billion to a record $2.353 TN (35% one-year growth), with Miscellaneous Liabilities up $306 billion (32% one-year growth) to a record $1.678 TN. 

Repo Liabilities gained $75 billion (9.9% ann.) to a record $3.116 TN, with one-year growth of $403 billion, or 14.9%. 

A key Bubble data point: Repo Liabilities ballooned $1.502 TN, or 93%, over the past 15 quarters.

At the epicenter of Bubble excess, Total System Repo Assets expanded $221 billion, or 10.5%, during the quarter to a record $8.669 TN – with nine-month growth of $683 billion, or 11.4% annualized. 

System Repo Liabilities surged $343 billion, or 20% annualized, to a record $7.165 TN. 

Curiously, Rest of World (ROW) Repo Liabilities jumped $169 billion, or 31% annualized, to a record $2.350 TN – with one-year growth of $342 billion, or 17.0%.

Money Market Fund Assets (MMFA) expanded another $152 billion to a record $8.441 TN – with one-year growth of $960 billion, or 12.8%. 

Over 15 quarters of historic monetary inflation, MMFA ballooned $3.357 TN, or 66%. 

Money Fund Repos holdings jumped $142 billion (19.5% ann.) during Q2 to $3.075 TN. 

Treasury holdings declined $145 billion to $3.282 TN, though one-year growth remained a blistering $668 billion, or 26%. 

Agency holdings gained $107 billion to a record $1.208 TN, with one-year growth of $215 billion, or 22%.

Rest of World (ROW) remains a key Bubble manifestation. 

ROW holdings of U.S. financial assets inflated a record $4.490 TN (30% annualized) during Q2 to a record $63.891 TN – with one-year growth of $7.904 TN, or 14.1%. 

ROW assets surged a staggering $20.692, or 48%, over the past 11 quarters – with assets up a crazy three-fold since 2008. 

Debt Securities holdings increased $105 billion, the slowest quarterly growth in six quarters. 

Interestingly, Treasury holdings declined $79 billion to $9.269 TN – reducing 11-quarter growth to $1.760 TN. 

Equities holdings inflated $3.273 TN during the quarter to a record $22.211 TN. 

More curious, ROW Repo Liabilities surged $169 billion during the quarter (31% ann.) to a record $2.350 TN – with 11-quarter growth of $876 billion, or 59%. 

It’s reminiscent of the then unprecedented $300 billion increase in ROW repo liabilities in 2006/07.