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On Global Borrowing Binge & Nuclear Fusion
Globally, countries have been spending way beyond their means, absolutely and as a percentage of GDP. And the problem has been worsening, Jackie reports. Rarely has global debt issuance as a percent of GDP approached the 23% expected this year. With higher interest rates escalating governments’ interest expenses and wars necessitating higher defense spending, the end of this tunnel is dark. … Also: A look at the junk bond funding of two data center construction projects. … And: The promise of nuclear fusion is attracting big bucks from Big Tech investors. Five fusion-focused startups are cases in point.
The Bond Yield Spectrum
I. From The Good To The Bad To The Ugly The spectrum of explanations for the rise in bond yields worldwide includes relatively benign ones to downright dangerous ones (chart). On the good side of the spectrum, better-than-expected economic growth has driven US bond yields up to levels that are back to normal. On the ugly side, soaring bond yields in France are signaling a looming debt crisis. In between are bad scenarios that explain the synchronized rise in global bond yields. These include the inflationary energy shock attributable to the war in the Middle East and the unwinding of the yen-carry trade. Let's have a closer look at the good, the bad, and the ugly: (1) R-star rising. R-star, or the neutral interest rate, is the real interest rate consistent with low unemployment and price stability. It balances the supply of savings with demand for investment. Three forces are pushing it higher. First, demand for capital is booming along with AI-related capital spending. Hyperscaler capex is expected to reach $750-$800 billion this year and $1.2 trillion next. Total US corporate bond issuance over the past 12 months through August was a record $3.0 trillion, including $1.4 trillion and $1.6 trillion issued by nonfinancial and financial corporations, respectively (chart). At the same time, US Treasury borrowing totaled $2.1 trillion over the past 12 months through September, including $1.3 trillion in notes and bonds (chart). Second, national savings faces demographic headwinds as retiring Baby Boomers stop saving and draw down their net worth (chart). Third, stronger productivity growth may be raising the return on capital and the economy’s sustainable growth rate (chart). The Fed's 175bps cuts in the federal funds rate since September 2024 have been completely offset by a comparable increase in the 10-year Treasury bond yield since then. Even at the start of this year, most Fed officials believed that the FFR was modestly restrictive, i.e., that it exceeded the neutral rate. In September, they acknowledged their error by hiking the FFR by 25 basis points, as Fed Chair Kevin Warsh said they had removed a "dose of accommodation," implying that the FFR is actually below the neutral rate! (2) Energy shock. Moving toward the middle of the spectrum are higher-for-longer oil prices. With US-Iran talks stalled and the US increasing its military assets, the risk of renewed escalation remains high. The longer energy costs stay elevated, the greater the risk they'll boost core inflation, forcing a more aggressive Fed response. If crude oil prices fall because more oil is getting through the Strait of Hormuz, diesel prices might remain elevated (chart). (3) Unwinding yen-carry trade. The yen-carry trade was based on ultra-low Japanese interest rates and a stable or weak yen. Now the BOJ is raising interest rates and the yen may be bottoming (charts). This is forcing traders to liquidate bond holdings previously financed with cheap Japanese money. (4) Debt crisis. At the far end of the spectrum is the "Revenge of the Bond Vigilantes." Between the Great Financial Crisis and the Great Virus Crisis, major central banks' ultra-easy policies enabled governments to run large deficits. The Bond Vigilantes were powerless. But now they are more powerful than ever because government debt is at record highs. Central banks have been forced to raise their policy rates as inflation has been more troublesome in recent years. Bond yields have soared this year worldwide as inflation rebounded and fiscal-risk premiums have risen. The danger is a self-reinforcing debt spiral: Higher yields raise interest costs, widen deficits, require more borrowing, and push yields higher still (chart). And, of course, higher yields increase the risk of causing a recession, which would exacerbate any debt crisis. In our view, the US should remain in the higher R-star end of the spectrum. We would start to worry about the debt-crisis danger zone if the US bond yield rises above nominal GDP growth (chart). In France, on the other hand, the Bond Vigilantes are pushing the 10-year government bond yield well above nominal GDP growth (chart). The French could be toast if yields continue to soar. II. The Fed Minutes The latest Fed minutes paint a familiar picture: a resilient economy, a firm labor market, and inflation that remains too high. We drew three key takeaways from the minutes of the Fed’s September 15-16 meeting. (1) Restrictiveness. Several participants said the current policy rate was not restrictive or only mildly restrictive, while a couple explicitly raised their estimates of the neutral federal funds rate. That fits neatly with our R-star story. (2) Macro backdrop. The Fed saw a resilient economy: real GDP is expanding at a solid pace, consumer spending has firmed, AI investment remains robust, and the labor market is close to maximum employment. At the same time, inflation remains elevated and risks were still skewed to the upside. (3) Rate outlook. All participants backed September’s 25bps hike, and most judged that another increase would likely be appropriate by year-end.
On The AI Economy, Brazil’s Election & Gangbuster Q3 Earnings
The economic impacts of the AI boom extend far beyond the leading providers and their executives. Today, Melissa assesses how AI is altering the general US economy—currently and how it’s expected to in the future. Also: William warns that Brazilian markets, keen to see President Lula ousted, may be celebrating prematurely. … And: Joe’s data on analysts’ aggregate consensus estimates suggest Q3 will be one for the record books, with all 11 S&P 500 sectors growing both earnings and revenues year over year.
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