The founder of the largest hedge fund in the world didn’t mince words when he was interviewed on the topic of the treasury market this week.
"We're going to have a debt crisis in this country. How fast it transpires, I think, is going to be a function of that supply-demand issue, so I'm watching that very closely." -@RayDaliohttps://t.co/s4ItGXwEna
— Jesse Felder (@jessefelder) September 28, 2023
What is driving us towards this “debt crisis” is a rapid rise in government debt driven by an unusually large fiscal deficit.
'Usually, deficits deepen during recessions as transfer payments to the unemployed increase. But in the US, this is that very rare deficit that has been accompanied by historically low unemployment levels.' https://t.co/y4xpyWkdlO by @johnauthers pic.twitter.com/qref2I9Tyu
— Jesse Felder (@jessefelder) September 29, 2023
At the same time, interest rates on all of that debt are also rising rapidly as major buyers have stepped back from the market.
"The Fed isn't a buyer, banks historically are a fraction of buying and now the banking system is shrinking. Put those together, Treasurys have to clear at a different price. That means higher yields—it's pretty simple." https://t.co/frS6xwYdZ7 pic.twitter.com/bLVU7aqmHH
— Jesse Felder (@jessefelder) September 25, 2023
As many emerging market economies are well aware, rapidly growing debt paired with rapidly rising interest rates is a recipe for a debt crisis.
"The rising risk premium in US Treasuries perhaps reflects tail-risk hedging against a situation where more debt leads to higher yields, as has occurred in some emerging markets." https://t.co/WFrf65RJlh pic.twitter.com/3qyjQDYCx5
— Jesse Felder (@jessefelder) September 28, 2023
At some point, the Fed may need to step in and intervene in the treasury market but that likely wouldn’t come without serious consequences for inflation.
'Intervention could involve buying bonds, thus undermining the central bank's mission to tighten policy until it defeats inflation, and resembles an official safety net for the trade.' https://t.co/uNxMwbi8zE
— Jesse Felder (@jessefelder) September 26, 2023
Brian Riedl recently wrote an important piece explaining the dynamics driving a potential “debt crisis.”
NEW from me at CNN. The 10-year bond hit 4.7% today. Washington never locked in those 1-3% interest rates, and now the debt is rolling over into these rates at the same time deficits soar too.
— Brian Riedl 🧀 🇺🇦 (@Brian_Riedl) October 2, 2023
If rates stay above 4% long-term, were in deep trouble. (1/)https://t.co/f9YMKlIBg0
Investors might like to think this matters only to the bond market but the historical relationship with stock valuations would suggest otherwise.
'Normally, a surge in real yields of this magnitude would have pushed the S&P 500's forward p/e ratio to 12 from 18 currently, Gross said. But the excitement about AI breakthroughs and rampant government spending have blunted the impact.' https://t.co/P2eHL3Z3Jj pic.twitter.com/T3HRE5RoQ3
— Jesse Felder (@jessefelder) October 4, 2023
There are more “corporate zombies” in the markets today than ever before, especially within the small cap space.
Around 1/3 of Russell 2000 companies aren't profitable--near the highest level in data going back to 1985 pic.twitter.com/A1OaGvm2YD
— Gunjan Banerji (@GunjanJS) October 2, 2023
While the broad stock market may not show it, these stocks are already beginning to price in the damaging effects of a rapidly rising cost of capital.
Russell 2000 1-month ROC < -10.00% https://t.co/s0k4Wg4Ozd by @NautilusCap pic.twitter.com/bJwgqV6C9j
— Jesse Felder (@jessefelder) October 4, 2023
And such relative weakness in the most interest-rate sensitive segments of the stock market has been an effective warning signal for the broader market in the past...
"The equity market's current resilience in the face of rising bond yields reminds me very much of events in 1987, when equity investors' bullishness was eventually squashed." -@albertedwards99https://t.co/O0EXXKGh3O pic.twitter.com/TKHdysUDsM
— Jesse Felder (@jessefelder) October 4, 2023
