Too Big To Fail Redux
Doug Nolan
An incurable optimist, I have the survival of humanity over the next decade as my base case.
But will the AI equities Bubble survive through the midterms?
Odds seem to oscillate by the hour.
The Semiconductor Index’s (SOX) 6.3% surge this week boosted y-t-d gains to 78.9%.
Trading to record highs, the MAG7 Index and Nasdaq100 (NDX) gained 3.1% and 3.3% this week.
It’s worth noting that the NDX rose 2.8%, the MAG7 3.5%, and the SOX 4.3% in curious Monday trading.
When referring to equities market “fun and games,” I’m thinking Monday trading dynamics.
The previous Friday was a $7 TN quarterly options expiration – the second largest.
Especially considering the backdrop, it’s reasonable to assume that an unusually large amount of put option exposure was exercised last Friday (leaving holders with short positions).
The backdrop provided an opportunity for yet another “rip your face off” short squeeze.
Not surprisingly, testy bond markets were not impressed.
A confluence of hawkish Fed officials, hot economic data, and recognition of an endless supply of debt securities weighs heavily on increasingly fraught funding markets.
The reality of the worst bond bear market in decades has begun to sink in.
Before going more granular, it is important to underscore a prevailing analytical focus: financial conditions have commenced a tightening process.
Much belatedly, the Fed is now focused on orchestrating a tightening of financial conditions necessary to contain increasingly powerful inflationary forces.
We’re entering a highly unstable and uncertain environment, with markets and economies incredibly unbalanced.
And it’s difficult to envisage finance in a more disorderly state.
The backdrop promises extraordinary dispersion in how various markets and sectors respond initially to tighter conditions.
For several years, unprecedented growth in speculative leverage created global liquidity overabundance.
Markets grew to misconceive that this most exceptional of financial landscapes was both ordinary and sustainable.
Vulnerability to tightened conditions is virtually systemic.
A brief heads up on how faltering Bubble dynamics tend to unfold: it’ll be as if problems just start to pop up all over the place – seemingly from all directions.
The unsuspecting, conditioned to count and extrapolate their bounty, will be caught by complete surprise.
Denial for a while, then consternation and confusion - everywhere.
It’s critically important to appreciate that egregiously loose conditions have for years masked myriad festering problems at home and globally, while emboldening untold scores of unrealistic expectations, crazy ideas, fantasy, and malign activities.
Infectious diseases have burrowed deep.
An initial unmasking is in the works – and it won’t be pretty.
And with Trillions of additional speculative leverage over recent years having created such an alluring veil, it’s only fitting that real ugliness is showing its face in the Treasury market.
“U.S. Treasury Yields Soar Most Since ‘Liberation Day’ Tariffs Shook Markets.”
“US Bond Sell-off Pushes Long-Term Yields to Highest Since 2004.”
“US 30-Year Yield Tops 5.5% in ‘Vacuum’ After Sentiment Gauge.”
“Great Bond Shakeout Locks in a 5% World ‘Until Something Breaks.’”
“Treasury Volatility Eyes Biggest Jump in Year as Bonds Churn.”
“The U.S. Bond Market isn’t Buying What Scott Bessent is Selling.”
“Soaring Bond Yields ‘Not Even Close’ to Cooling Red-Hot US Economy, Investors Say.”
It’s worth noting that Wednesday was the worst day of a miserable week.
The session saw 10-year Treasury yields surge 15 bps to 5.12%.
That morning’s PMI data confirmed heightened fears of red-hot economic overheating.
The headline Manufacturing PMI index jumped three points to 57, “best reading since 2002.”
Manufacturing New Orders were at the high since April 2022, with the employment gauge at highs since February 2021.
The Services PMI rose to the strongest level since October 2021 (58.7).
The Services Employment gauge rose to the highest since June 2022, with New Orders at the high back to March 2022.
The Atlanta Fed GDPNow Forecast is currently running at a blistering 5%.
Bloomberg (Jeffrey Sparshott) quoted Chris Williamson, chief business economist at S&P Global Market Intelligence (provider of PMI data): ‘Business is clearly booming now in both manufacturing and services.
However, this growth is being accompanied by some of the most severe supply chain bottlenecks seen in the near-two-decade survey history if the pandemic is excluded, with companies also reporting increasing problems finding suitable staff.”
The week also saw stronger-than-expected August New Home Sales, another week of initial jobless claims below 200k, and a monstrous Q2 Current Account Deficit ($246bn).
Friday data had University of Michigan one-year inflation expectations holding at 4.6%, along with August’s much stronger-than-expected 1.6% monthly jump in “core” (non-defense, ex-air) Capital Goods Orders – certainly boosted by AI spending.
An interesting headline: “AI is Crowding Out Demand for US Treasuries.”
September 25 – Bloomberg (Marton Kasnyik):
“Spending on AI infrastructure by the five largest US hyperscalers is set to increase by more than half next year to $1.2 trillion, according to… Goldman Sachs...
That figure is above the Wall Street consensus of $1.1 trillion in 2027 capex, the team led by Ryan Hammond said...
‘Based on consensus estimates, capex in 2027 is on track to reach a larger share of GDP than any technological investment cycle since the railroad build-out in the late 1800s,’ Hammond and his colleagues said.
Amazon.com Inc., Alphabet Inc., Microsoft Corp., Oracle Corp. and Meta Platforms Inc. are on course to spend $800 billion this year developing their AI capacity.”
An imaginary headline:
“AI is Crowding Out Demand for MBS and Housing.”
Benchmark MBS yields surged a notable 23 bps this week, with a brutal 54 bps three-week spike.
Actual headlines:
“US Mortgage Rates at 7% Are Forcing Home Sellers to Slash Prices.”
“Eroding Homebuyer Purchase Power Hitting House Sales, Prices.”
“8% Mortgage Rates are ‘Not an Impossibility’ as the 30-Year Fixed Rate Surges.”
It’s worth noting that the 30-year fixed mortgage rate jumped this week to the high since January 2025, with the 15-year rate to the high since May 2024.
A historic (mega-Trillions) global AI arms race, in a new paradigm of higher market yields and tighter conditions, raises so many issues it’s difficult to know where to start.
Borrowers of all stripes better hope AI debt is not the driving force behind tanking bond markets.
Serious cracks this week.
September 24 – Financial Times (Toby Nangle):
“Oracle has sent a notice to a unit of Blue Owl Capital citing ‘force majeure’ on its lease obligations starting 2028 for Project Jupiter, reporting that: ...
Oracle is seeking to assert its contractual position if the build out is delayed.
Still, it’s not certain that such a maneuver would free Oracle from its previously agreed financial obligations.
Project Jupiter is part of the massive Stargate infrastructure buildout that readers might recall as being one of the bigger blobs on the cool AI-interconnection-chart.
And, as MainFT reported a week ago, around $18bn of loans tied to the development are trading, if not distressed, then certainly ‘stressed’ territory of ca 90c in the dollar.
It does seem a bit rough that Oracle might be on the hook for hefty rental payments starting 2028 as anchor tenant of a massive data centre complex if the complex is just a hole in the ground.”
September 25 – Wall Street Journal (Peter Rudegeair, Anissa Gardizy and Matt Wirz):
“Oracle set out last year to lease a massive AI data-center campus being built in New Mexico’s Doña Ana County, part of a blitz of deals to create computing power for OpenAI.
The company made aggressive financial commitments for the facility in contracts that allow it little wiggle room.
Now, ‘Project Jupiter’ is mired in challenges over power supply and permitting and is fast becoming a prime example of the risks in the tech giant’s sprawling and expensive artificial-intelligence gambit.
Oracle signed a lease for the New Mexico facility with so-called hell-or-high-water terms, meaning the deal can’t be terminated and Oracle is obligated to make rent payments regardless of whether it has secured the power to operate the data centers…”
Oracle (10-yr) yields spiked another 37 bps to close the week at 7.34%.
This bond was issued in February with a yield of 5.73%.
Oracle CDS surged 44 this week to a record 237 bps (2008 crisis high 198bps), after beginning the year at 31 bps.
Nvidia CDS jumped 11 bps to a record 87 bps, after starting 2026 at 42 bps.
Amazon (10-yr) yields jumped 18 bps to 5.95%, up 50 bps in a month.
Microsoft (10-yr) yields surged 19 bps to 5.51% - with a one-month rise of 48 bps.
Rising 19 bps this week to 6.13%, Meta yields surged 40 bps in 30 days.
September 20 – Financial Times (Ryan McMorrow, Michelle Chan and Michael Taffe):
“Big Tech companies are rapidly expanding their use of guarantees to back debt for AI data centres and chips, issuing up to $300bn in commitments in less than a year while recording little of that exposure on their balance sheets.
First used by Meta on a huge data centre project last autumn, so-called residual value guarantees have been taken up by Broadcom as part of its chip financing deal for Anthropic and by Nvidia to offer support to OpenAI and other customers buying its chips.
These arrangements, under which tech companies guarantee a minimum future value for chips or data centres, join a growing set of creative financing structures embraced by Big Tech to accelerate the AI infrastructure boom.
According to an FT analysis, tech giants have offered up to $300bn in these guarantees in the past 12 months alone.”
September 24 – Reuters (Howard Schneider):
“The artificial intelligence buildout is on track to require a larger share of US output than the rollout of electricity, railroads, interstate highways or the internet, with an increasingly complicated financial structure that poses potentially systemic risks, according to a new study.
What had been paid for out of the cash stockpiled by companies like Amazon.com, Meta Platforms and Alphabet's Google has morphed into an expansion that will consume around 3.6% of gross domestic product annually through 2032, or more than $10 trillion, and is using ever more intricate financing arrangements, Stijn Van Nieuwerburgh, a finance and real estate professor at Columbia Business School, wrote…
Just as the rail and telecoms expansions led to notable bubbles and busts, Van Nieuwerburgh wrote that the extent of the buildout, the still-untested revenue streams, and the intricate financing structure emerging around AI mean it could be primed for a fall.
‘This is freaking complicated,’ he said… of the arrangements emerging between AI firms, major tech hyperscalers, banks, private credit lenders, real estate firms, and a host of other players involved in building what he conservatively estimated at 183 gigawatts worth of new data-center capacity over the next seven years, compared with about 57 gigawatts currently installed.”
“This is freaking complicated” AI finance is on a collision course with a new market paradigm of tighter conditions, risk aversion, less appetite for leverage, and general data center antipathy.
I suspect sophisticated AI financial engineering is on borrowed time.
What is a partially constructed data center worth?
One completed without sufficient power resources?
With risks of a spectacular bust rapidly rising, are really expensive AI chips sound loan collateral?
Bloomberg’s always insightful John Authers’ Friday piece ran with the title “The Big One Is Rumbling in the Bond Market.”
“In financial terms, this is truly an earthquake.
What is strange, however, is that even though 10-year government bonds are the financial bedrock, setting the risk-free rates from which virtually all transactions are ultimately priced, they are showing little sign of damaging anything else, either in the markets or the real economy.
The Nasdaq 100, one of the world’s most widely tracked indexes, hit a new all-time high this week even as yields were tipping upward.”
“Strange” indeed.
The MOVE (bond volatility) Index closed Friday at 105, the high since March’s acute market instability.
High yield CDS traded intraday Friday to 324 bps, the high back to May.
High yield spreads (to Treasuries) widened 27 this week to 294 bps, the widest level since early April.
It’s worth noting that the last time the MOVE Index was at 105, the VIX traded above 30, and when high yield spreads were last at 294, the VIX was above 25.
The VIX ended this week at 14.87.
What to make of it all – the disconnect between serious debt market tumult and buoyant technology stocks (and equities more generally)?
Strange, but not an unfamiliar dynamic.
AI has become the classic “too big to fail” – just like the West would never allow Russia to collapse (1998), and Washington would never tolerate a housing bust.
AI has come to command a stock market Bubble that dominates household perceived wealth - fundamental to the “resilient” U.S. Bubble economy.
Importantly, the too big to fail dynamic consumes a scheming administration that operates on its own terms.
Too big to fail with five weeks until high-stakes midterm elections.
Of course, the President won’t say or do anything that would risk pricking such a momentous Bubble.
Meanwhile…
September 24 – Bloomberg (Srinivasan Sivabalan):
“The vaunted emerging-market carry trade is showing signs of cracking as losses mount and volatility jumps.
High Treasury yields are finally eroding the appeal of riskier assets.
A gauge of dollar-funded carry returns from eight major EM currencies is headed for the biggest monthly decline since March.
The widespread losses include popular trades such as the Colombian peso and Hungarian forint.
At the same time, currency implied volatility is rising by the most since March.”
September 25 – Bloomberg (Vinícius Andrade and Nicolle Yapur):
“The surge that sent US Treasury yields to the highest in decades is threatening carry trades that had become the go-to strategy for emerging-market investors this year.
Citigroup Inc. closed its carry basket that included long positions in the South African rand, Mexican and Colombian pesos and Turkish lira against the Canadian dollar and Swiss franc.
The move came after a strong US PMI report, a weak 5-year Treasury auction and geopolitical headlines stoked volatility in Markets...
‘We have shown in the past that carry typically does poorly during high volatility and high crowding periods,’ analysts wrote.”
EM currency losses this week included the Colombian peso’s 3.95%, the Mexican peso’s 2.56%, the Peruvian sol’s 1.7%, and the Hungarian forint’s 1.1%.
The iShares Emerging Market Bond ETF (EMB) lost 1.3% this week, the weakest performance since May.
It’s down 2.4% over three weeks, the worst drubbing since March.
EM dollar-denominated bonds (in particular) were taken out to the woodshed.
Mexico ($) yields surged 30 bps this week to 6.92% - the high since March 2009 (up 109bps y-t-d).
Colombia ($) yields jumped another 21 bps to 7.43% - up 77 bps in a month to a one-year high.
Yields rose 24 bps in Peru (6.04%), 23 bps in Panama (6.40%), 16 bps in Brazil (6.59%), and 15 bps in Chile to a three-year high of 5.85%.
Argentina yields spiked 90 bps to 11.25% - with a one-month rise of 148 bps.
In Asia, dollar-denominated Philippine yields jumped 23 bps to 6.04% - the high back to 2008. Indonesia ($) yields rose 18 bps to a three-year high of 6.04%.
De-risking/deleveraging has gained important momentum.
September 24 – Reuters (Anirban Sen and Gertrude Chavez-Dreyfuss):
“Like Treasuries themselves, the Treasury basis trade has fallen out of favor lately.
Funds locked up in leveraged basis trades are down 20% this year to $1.2 trillion, Morgan Stanley estimates.
The decline reflects a mostly uneventful rise in US interest-rate expectations and improved trading conditions, both of which tend to limit the trade's profitability…
‘The basis position in the market has been declining because the opportunity set is lower,’ said Meghan Swiber, US rates strategist at Bank of America. ‘
The other part of this is that asset manager demand for Treasury futures has also been moderating.’”
I’ll conclude with the opening question: will the AI equities Bubble survive through the midterms?
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