From: allin
Current market conditions present an unusual divergence in assets, prompting analysts to try and understand the underlying dynamics [09:27:00]. This divergence includes falling bonds, spiking gold prices, and a rising S&P 500 [09:38:29].
Unprecedented Market Anomalies
US Treasury yields have spiked due to declining bond prices, with the 10-year yield reaching over 4.25% after dropping as low as 3.5% in September [09:38:29]. Meanwhile, gold, typically considered a safe asset, has surged from around 2,750 an ounce, making it one of the best-performing assets [10:03:00]. Surprisingly, equities, as represented by the S&P 500, have also seen a significant, seemingly endless run-up to all-time highs [10:22:00]. The US dollar remains strong, and backend yields are rising [11:01:00].
Chamath Palihapitiya suggests that this market behavior reflects the global financial infrastructure repositioning itself for a potential Trump victory [11:29:00]. This expectation stems from the belief that a Trump economic plan would drive better growth, potentially leading to more inflation and a higher risk premium [11:48:00]. If Trump wins, assets like gold and Bitcoin are expected to rise further, equity prices could increase due to short-term economic upside, but long-term rates would also be pushed out, making the inflation outlook murkier [13:10:00].
Inflation Concerns and Monetary Policy
Paul Tudor Jones indicates that “all roads lead to inflation,” suggesting that the market fears inflation is not fully controlled and could resurface [14:43:00]. This fear could lead the Federal Reserve to pivot from its current stance and raise interest rates again [14:56:00]. As a result, both Paul Tudor Jones and financial legend Stan Druckenmiller are wary of fixed income assets, with Druckenmiller holding a 20% short position on US treasuries [15:00:00].
Since the Federal Reserve’s 50 basis point rate cut on September 18th, the 10-year Treasury bill yield has risen by 60 basis points [15:26:00]. This suggests that the market reacted negatively to the Fed’s “overly precipitous” cut, especially since previous 50 basis point cuts (2001 and 2008) occurred on the verge of major recessions, contradicting current rhetoric of a strong economy [15:46:00]. Recent inflation data (core CPI) has shown slightly higher than expected figures, reinforcing market concerns that inflation is not yet “whipped” [16:35:00].
US National Debt and Economic Implications
The US fiscal picture is a significant concern for the market [17:58:00]. Interest payments on the national debt have become “absolutely parabolic” in recent years, reaching a run rate of 3,500 per American [17:01:00]. This represents 20-25% of federal revenue now going towards debt service [17:21:00].
There was an expectation that interest on the debt would decrease with rate cuts and a return to a 2% 10-year bond yield [17:26:00]. However, with the current inflation outlook and the bond markets pricing in higher interest rates for longer, this scenario appears unlikely [17:52:00].
Regardless of the presidential election outcome, both candidates’ plans suggest an increase of another 68 trillion, with an estimated $4 trillion annually spent on debt service, representing 15% of every dollar exchanged [21:57:00].
Global Macroeconomic Trends and Challenges
The problem of leverage is not unique to the US but is a global challenge [22:47:00].
- United Kingdom: Faces a budget deficit of 4.4% of GDP while its economy grows at only 0.9% annually, leading to proposals for higher taxes [22:54:00].
- France: Grapples with a major budget crisis, struggling to reduce its deficit from 6% to 5% of GDP amid skyrocketing bankruptcies [23:06:00]. Measures include raising taxes on large firms and a temporary surcharge on high incomes [23:27:00].
- Brazil: Experiencing a major budget crisis with states owing $130 billion to the federal government, accelerating inflation (4.6%), which is expected to push rates higher and longer [23:46:00].
This global leverage problem explains the flight to “safety” assets like gold and Bitcoin [23:59:00]. The fundamental question is whether the US dollar can maintain its reserve status, as the Federal Reserve may inevitably need to monetize the debt by printing money, given that China, historically the largest buyer of US treasuries, has been selling them off and buying gold instead [24:11:00]. China’s treasury holdings are back to nearly 15 years ago’s levels [24:46:00].
Economic Outlook and Policy Implications
The current market environment suggests a repositioning towards assets that benefit from inflation, such as gold, Bitcoin, and equities, as more money is pumped into the system [25:15:00].
There is a consensus that neither political party is likely to cut spending, with projections of another $10 trillion in debt over the next administration [18:44:00]. This spending could create a “massive bubble in equities” [20:56:00].
Howard Marks explains that investing in equities and bonds are fundamentally opposite [44:37:00]. Bonds provide fixed income, which is debased by high inflation, while stocks offer earnings, which companies can raise prices to protect against inflation [45:27:00]. However, both are negatively impacted by rising interest rates due to a higher discount rate [45:50:00].
The US may be entering an era of “consequences” after 15 years of “consequence-free spending” and normalized emergency conditions since 2008 [47:07:00]. This means the government can no longer avoid trade-offs [47:11:00]. If higher inflation is tolerated (monetizing the debt), bond markets will demand higher interest rates, impacting equities, real estate, and home values [47:20:00]. Conversely, tackling inflation requires the Fed to tighten, which would force the federal government to become fiscally responsible and curb spending [47:43:00].
Political Implications for Fiscal Policy
The current election cycle is characterized by both candidates proposing increased government spending, leading to a projected increase in the deficit [48:58:00]. This suggests that irrespective of who wins, the market anticipates continued fiscal expansion [49:08:00].
While cutting government spending might technically reduce GDP, it could also unlock resources for the private sector, leading to greater efficiency and stimulation [52:53:00]. With the economy currently at full employment, this is an opportune time to implement such cuts, as the private sector could reabsorb government workers, making the transition less painful than during a downturn [53:20:00].