And yet one wonders if the next bear market will be easily mitigated by opening the flood gates. If (and this is an admittedly big if) we're talking about Herbert Hoover v.2, namely a protectionism-fed global recession, at what point will the bond market get too jittery? Empirical data works, until you have an unprecedented situation.
True, but for now it seems US Treasury markets are worried about federal deficits under Trump. the bond vigilantes are circling in the US since Trump won the election...
I like the fact that JK cites authorities for his views. That increased fiscal spending causes Treasury rates to rise seems clear. At the same time JK argues that the authorities can absorb the changes. The concern is that they can until they cannot - if some major crisis overwhelms the markets. This is a long way off but could happen. In the meantime Treasuries are solid - except for the interest rate.
"To cut a long story short, he found that on days when the US government introduced spending decisions to rescue the economy, real yields increased, driving bond prices down."
I've always wondered if this is a "chicken and egg" question; do bond yields increase because bond prices go down, or do bond prices go down because bond yields increase? Also, why did fixed income people come up with this backwards math in the first place? I guess it's akin to that old aphorism "whether the glass is half-full or half-empty depends on whether you're pouring or drinking".
The U.S. national debt situation has become increasingly precarious, with debt accumulation accelerating at an unprecedented pace of approximately $1 trillion every 100 days. As of late 2024, the total debt approaches $36 trillion, reflecting a sharp upward trajectory that could exceed $50 trillion before 2030 and faster if economic or other shocks occur.
Current fiscal metrics paint a concerning picture:
- Federal Revenue: ~$5 trillion
- Federal Spending: ~$7 trillion
- Interest Payments: Over $1 trillion annually at ~4% rates
- Annual Federal Budget Deficit: ~$2 trillion
This creates an unsustainable cycle where:
1. Rising interest payments consume an ever-larger portion of the federal budget
2. The gap between revenue and spending continues to widen
3. Social Security's trust fund faces depletion within 8-10 years
4. The "too big to fail" doctrine encourages risky corporate behavior
Historical reference points are illuminating:
- The last balanced budget (1999/2000) demonstrates fiscal balance is possible
- Post-2016 shift in Republican fiscal stance marked a departure from traditional conservatism
- Recent crises have normalized massive federal interventions
Looking ahead, several factors could accelerate the debt crisis:
We cannot escape every mess by increasing debt and not reducing the debt during good times. The reckoning is coming sooner or later, and it is not a question of if but when. The politicians’ desire to kick the can down the road will not work forever. Someone will have to make difficult decisions.
While I'm all about evidence-based, this is not a standard of evidence that would stand up to scrutiny in any other field. What you (and presumably this paper) have done is found a correlation and simply asserted that your causal path between the two is correct.
What if bond yields rise when expansionary fiscal policy changes are announced because expansionary fiscal policy is inflationary and inflation leads to higher rates? What if prices just fall in anticipation of an increase in supply?
Looking at the survey results, wouldn’t you tend to believe that the US is now literally ‘too big to fail’ for the entire world?
There is indeed ample empirical evidence that shows that the deficit is indeed unsustainable, but wouldn’t you say that it is mostly human psyche that pushes investors to keep pouring money into the pit, since the alternative – a US default and its consequences – are too scary to imagine / face?
I agree, the US is too big to fail and if it starts to fail the Fed will step in and buy the government debt to stabilise the bond market similar to what the ECB has done during the European debt crisis. That is the only way to deal with the situation.
This is something I have been thinking about a lot:
This cycle is basically kept alive on the belief that the Fed / any other Central Bank can bail the big governments without any seeming difficulties or consequences. For the cycle to break, a critical mass of investors then has to believe that the Fed can no longer do this job properly.
Has there been periods throughout history when reversal of faith in these institutions have effectively brought about a ‘financial reset’ / recession / crisis? What would need to happen today for us to no longer think that the system would work as intended?
As for the loss of trust in central banks, I have been thinking about that as well for some time. the only periods of 'reset' I can think of in terms of loss of trust in central banks/governments are wars and hyperinflations, but all of these resets haad other external triggers that are not applicable to the US and other Western nations today (mostly defeat in a war or the loss of territory/resources with which to fund debt repayments).
So, I am at as loss in what to expect if such a loss of trust in central banks were to happen. However, in my more than two decades as a professional investor I have learned one important lesson: If the proverbial hits the fan and we face a major crisis where the downside is too big, we will simply change the rules. It's what happened in 2009, during the European debt crisis and again during the pandemic. If investors were to lose trust in the Fed or any other major central bank, I fully expect that laws will be passed to force investors to hold US Treasuries thus creating 'trust at gunpoint'. Or any other solution indeed to prevent the Treasury market from collapsing. The costs of that event are simply too large to stomach.
I don't own any bonds, but that is just because of my long investment horizon.
As for Treasuries, I have no problem holding Treasuries. Just because there is a risk premium doesn't mean one should not own them. It depends on what you want to get out of them, what your time horizon is, and if the risk is compensated adequately. I think at the moment, if you have an investment horizon of five years or less, the risk is adequately compensated and it is ok to hold them at current yields.
Brilliant illustration with so much fundamentalism .
A case well-made, thanks.
And yet one wonders if the next bear market will be easily mitigated by opening the flood gates. If (and this is an admittedly big if) we're talking about Herbert Hoover v.2, namely a protectionism-fed global recession, at what point will the bond market get too jittery? Empirical data works, until you have an unprecedented situation.
True, but for now it seems US Treasury markets are worried about federal deficits under Trump. the bond vigilantes are circling in the US since Trump won the election...
Superb observation!
I like the fact that JK cites authorities for his views. That increased fiscal spending causes Treasury rates to rise seems clear. At the same time JK argues that the authorities can absorb the changes. The concern is that they can until they cannot - if some major crisis overwhelms the markets. This is a long way off but could happen. In the meantime Treasuries are solid - except for the interest rate.
"To cut a long story short, he found that on days when the US government introduced spending decisions to rescue the economy, real yields increased, driving bond prices down."
I've always wondered if this is a "chicken and egg" question; do bond yields increase because bond prices go down, or do bond prices go down because bond yields increase? Also, why did fixed income people come up with this backwards math in the first place? I guess it's akin to that old aphorism "whether the glass is half-full or half-empty depends on whether you're pouring or drinking".
Whilst I'm not an adherent of modern monetary theory https://en.wikipedia.org/wiki/Modern_monetary_theory , I also wonder whether the German "debt brake" https://en.wikipedia.org/wiki/German_balanced_budget_amendment has done more harm than good. In any case, defending it just cost the Finance Minister his job and drove new elections on 23 Feb 2025.
The U.S. national debt situation has become increasingly precarious, with debt accumulation accelerating at an unprecedented pace of approximately $1 trillion every 100 days. As of late 2024, the total debt approaches $36 trillion, reflecting a sharp upward trajectory that could exceed $50 trillion before 2030 and faster if economic or other shocks occur.
Current fiscal metrics paint a concerning picture:
- Federal Revenue: ~$5 trillion
- Federal Spending: ~$7 trillion
- Interest Payments: Over $1 trillion annually at ~4% rates
- Annual Federal Budget Deficit: ~$2 trillion
This creates an unsustainable cycle where:
1. Rising interest payments consume an ever-larger portion of the federal budget
2. The gap between revenue and spending continues to widen
3. Social Security's trust fund faces depletion within 8-10 years
4. The "too big to fail" doctrine encourages risky corporate behavior
Historical reference points are illuminating:
- The last balanced budget (1999/2000) demonstrates fiscal balance is possible
- Post-2016 shift in Republican fiscal stance marked a departure from traditional conservatism
- Recent crises have normalized massive federal interventions
Looking ahead, several factors could accelerate the debt crisis:
- Proposed Trump’s expansionary policies, adding $7+ trillion
- Rising interest rates increasing debt service costs
- Aging population straining entitlement programs
- Potential economic shocks requiring additional intervention
We cannot escape every mess by increasing debt and not reducing the debt during good times. The reckoning is coming sooner or later, and it is not a question of if but when. The politicians’ desire to kick the can down the road will not work forever. Someone will have to make difficult decisions.
You can see all the data here: https://www.usdebtclock.org/
While I'm all about evidence-based, this is not a standard of evidence that would stand up to scrutiny in any other field. What you (and presumably this paper) have done is found a correlation and simply asserted that your causal path between the two is correct.
What if bond yields rise when expansionary fiscal policy changes are announced because expansionary fiscal policy is inflationary and inflation leads to higher rates? What if prices just fall in anticipation of an increase in supply?
Hi there,
Looking at the survey results, wouldn’t you tend to believe that the US is now literally ‘too big to fail’ for the entire world?
There is indeed ample empirical evidence that shows that the deficit is indeed unsustainable, but wouldn’t you say that it is mostly human psyche that pushes investors to keep pouring money into the pit, since the alternative – a US default and its consequences – are too scary to imagine / face?
Thanks again for your well-written contributions!
I agree, the US is too big to fail and if it starts to fail the Fed will step in and buy the government debt to stabilise the bond market similar to what the ECB has done during the European debt crisis. That is the only way to deal with the situation.
Thank you for replying!
This is something I have been thinking about a lot:
This cycle is basically kept alive on the belief that the Fed / any other Central Bank can bail the big governments without any seeming difficulties or consequences. For the cycle to break, a critical mass of investors then has to believe that the Fed can no longer do this job properly.
Has there been periods throughout history when reversal of faith in these institutions have effectively brought about a ‘financial reset’ / recession / crisis? What would need to happen today for us to no longer think that the system would work as intended?
So, I have painted a picture of how I imagine the monetary policy of the future here: https://klementoninvesting.substack.com/p/is-this-the-monetary-policy-of-the
As for the loss of trust in central banks, I have been thinking about that as well for some time. the only periods of 'reset' I can think of in terms of loss of trust in central banks/governments are wars and hyperinflations, but all of these resets haad other external triggers that are not applicable to the US and other Western nations today (mostly defeat in a war or the loss of territory/resources with which to fund debt repayments).
So, I am at as loss in what to expect if such a loss of trust in central banks were to happen. However, in my more than two decades as a professional investor I have learned one important lesson: If the proverbial hits the fan and we face a major crisis where the downside is too big, we will simply change the rules. It's what happened in 2009, during the European debt crisis and again during the pandemic. If investors were to lose trust in the Fed or any other major central bank, I fully expect that laws will be passed to force investors to hold US Treasuries thus creating 'trust at gunpoint'. Or any other solution indeed to prevent the Treasury market from collapsing. The costs of that event are simply too large to stomach.
So what do you own then for bonds? People hold treasuries due to the historical lower correlation with equities vs high yield and corporate.
I don't own any bonds, but that is just because of my long investment horizon.
As for Treasuries, I have no problem holding Treasuries. Just because there is a risk premium doesn't mean one should not own them. It depends on what you want to get out of them, what your time horizon is, and if the risk is compensated adequately. I think at the moment, if you have an investment horizon of five years or less, the risk is adequately compensated and it is ok to hold them at current yields.