Cracks in sovereign bonds spreading?
The trigger of the bond rout in the past month has caused some severe volatility spikes in so many asset markets that it is worth us spending some time looking into the cause, and effect of this symptom. The event was the record high US bond sale yield made in end-July auctions (Article 2)…
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Of course, as the chart above illustrates, this is not an isolated incident in the US debt market, in fact all OECD govts are facing a crisis of trust, where market believe in their credentials as ‘risk free’ instruments are now doubted, and this is reflected in the almost synchronised yield spikes, with the Japan yield staging the most spectacular rise in 2026!
Socialism the source of Western debt woes
The cause for this suddent flip in market confidence did not come suddenly overnight it is the result of decades of deficit spending, and politicians promising endless welfare, and issuing mountains of debts to finance it, ending at where we are not – the point of no return, where physics takes over:
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When the govt budget is nearly 60% of the total economic output, you know high taxes are not far behind, and of course, the crowding out effect of govt activities is also reaching dangerous levels. What is interesting is how quickly the USA got addicted to this game (yellow line), only after the GFC – the crisis that gave central banks the carte blanche to print to help fight crisis after crisis:
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Of these the Japanese have the worse intervention in the free market as its CB owns over 100% of its GDP in balance sheet assets (mostly JGBs?)…
Inflation now left the train station
With endless money printing – through CB purchases of govt papers, and artificially low interest rates (yep, none of the CBs are setting rates with inflation at or below their target rates of late), and forever wars disrupting all global supply chains, inflation is set to accelerate much more than people realise (eg oil price eased by massive release of strategic reserves, consumer prices cushioned by inventory as cheaper old prices, food prices yet to reflect diesel and fertiliser price hikes, etc). What is certain for sure, is China’s PPI (red line below) will rise further (and the country being better stocked strategically than most western countries, will definitely see a milder PPI spike than elsehwere):
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This will filter into CPI this time in a way never seen in past cycles – because in the past PPI were restrained by new supplies, but this time we will have no new supply coming as all materials are either stranded, sanctioned, or destroyed by geopolitics…
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The rise in rates is full spectrum and accelerating, take one of our sources – even the resource rich NZ – interest market is seeing trend rises, accelerating into the recent bond collapse:
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Short term fixes will come back to bite
What do govts do besides forcing pensions, CBs to buy? They issue shorter duration debts in the hope that rates will fall later:
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But any jitters in the geopolitical front, or a debt default, could trigger the next bond burst (ie govts unable to sell below pre-auction yields), with premium (also called auction tail, red area below) rising into future years when markets either get spooked by undersubscription or mainly CB buying of bond auctions:
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As the interest and flood of debt supply both rise, govts will soon be hitting record highs in interest servicing burdens – a first stop for the US could be 23% last achieved in the late 80s, but this time we could exceed that handsomely given how large the debt load is compared to the 1980s:
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Note – even during the WW2, the US Treasury interest spending stayed at the low end of the post-war range, showing how much more indebted we are now compared to then…
Hyperbolic rise in debt servicing cost begins
With US interest cost hitting $1.4trn by some estimate and likely to accelerate further as rates climb (yellow line below), the impact on rest of the economy, let alone bond market, is beginning to be felt.
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No wonder, despite record high stock market prices and low headline unemployment rates, with the elder generations feeling most bearish; even the youngest cohorts are hitting lowest confidence levels (red and dark blue lines):
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End of the central banking cult
For most pundits who follow the Fed’s minutes, or the MPC guidance, ECB musings, the game may be about to change, as thes gods of finance lose control of their games. In fact, they are customarily wrong in their predictions or forecasts, as is clearly shown here:
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Perhaps the Fed is being honest this time, by projecting a major spike in debt/GDP ratio, but our guess is that even that will be woefully inadequate, just like their 2017 forecasts…
Self protection – in gold and real asset only
As debt explodes, like in Weimar Germany, it becomes devastating, when fiat loses its meaning and people hide in gold and real estate, this was what it looked like:
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No wonder the smart money have already ditched hoarding fiat reserves and went straight for the yellow metal, some doing so under the radar screen like China:
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But ever one is at it, as the confidence in other people’s paper evaporate, so is the trust in other govts safekeeping your own gold disappearing, for example:
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Is it any wonder that China’s gold reserve has quardrupled, while its treasuries holdings are down by 63% (both in % weighting terms):
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Another form of distrust of govt is of course when people start voting for leaving the govt that rules over them – past examples include Brexit, we will have Alberta independence vote this Nov also, and even a tiny British village is thinking of the same (Article 1)…
Which is the first flashpoint?
Most market focus is on the US debt problems, but the likely first to fall are Japan or Europe, the former facing too great a catch up on too perilous a starting point (see far right in chart below), and the latter being embroiled in two wars that kills its energy and food supplies, not to mention the lack of economic growth.
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In summary, the big blow out may well be outside of the USA despite its large share of financing needs:
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Position for the fallout – sell bonds now
By forcing pensions to buy ‘risk free’ bonds, govts have created a sure source of demand, but when the risk free becomes high risk, pensions could not only see their own liquidity crisis, but could trash the asset through their own stampede out of it – collectively pensions own some 60% sovereign debts vs 40% corporate bonds:
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We have been advocating real assets as the safe haven, and even gone as far as suggesting real estate in commodities heavy (ie real asset heavy) jurisdictions. These are of course illiquid, so prepare to allocate some short term win cash for immediate daily needs, and precious metals for large allocation that is also portable in times of crisis…
One final through for our HK heavy readers – The new geopolitical reality may benefit the Fragrant Harbour city, as well argued in article 3, but we believe this eventuality is probably post crisis win for HK, and less an automatic ascent as the crisis unfolds… so perhaps lighten up in HK could avoid any unforseen sanctions or other empire moves as the US-CN decoupling inevitably worsens.
Article 1
Tiny England village plans referendum on leaving U.K., joining U.S. to protest migrant housing plan
https://www.cbsnews.com/news/uk-piddington-village-referendum-leave-uk-join-us-protest-as-housing-plan/
Article 2
US Sells 30-Year Bonds at Highest Interest Rate Since 2001
https://www.theepochtimes.com/us/us-sells-30-year-bonds-at-highest-interest-rate-since-2001-post-6075156
Article 3
A Shifting Global Currency Landscape
https://research.gavekal.com/article/a-shifting-global-currency-landscape/
English 
Chinese