The David Tao Global US bond market continues to decline, and even weaker-than-expected employment and inflation data have failed to reverse bond investors' pessimistic sentiment. The yield on 10-year Treasury notes has risen to a rare high not seen since 2002, triggering volatility across global government bond and credit bond markets. The latest US core PCE shows inflation cooling down, while September's job growth fell far short of market expectations. Several senior Federal Reserve officials have also cast doubt on a rate hike in October. Futures markets have priced in only an 18% probability of a rate hike in October, yet market vigilance over rising funding costs remains unchanged. Stock markets have generally reacted mildly to rate hikes, but apart from the Nasdaq, the other two major indices have begun to fall. Spurred by rising US Treasury yields, the US dollar exchange rate has climbed, and gold, silver, and commodity prices have all corrected downward. With the US-Iran conflict showing no end in sight, Brent crude futures continue to rise, while US oil futures have stopped rising and started to retreat.
US personal consumption, adjusted for inflation, expanded by 0.6% month-on-month in August—the fastest spending pace since the end of 2024. Despite rising living costs, demand for big-ticket items such as automobiles and furniture remains strong. Robust stock markets and a vibrant labor market continue to support economic activity. Second-quarter GDP annualized growth was revised upward from 1.5% to 2.2%, and the Atlanta Fed's GDPNow model suggests current US economic growth is around 5%.
The market's more closely watched PCE index rose 0.3% month-on-month and 3.4% year-on-year, in line with expectations. The core PCE index rose 0.2% month-on-month and 3% year-on-year, showing inflation momentum weaker than expected. Since the Fed's rate hikes cannot alter geopolitical situations or oil supply, investors are focusing more on core inflation data. Non-farm payrolls in September increased by only 29,000, far below analysts' forecast of 82,000, and the figures for the previous two months were also downwardly revised. Single-month employment data are generally volatile and should not be used to determine a trend, but at the very least, they provide the Fed with the possibility of pausing rate hikes and observing the situation.
In response to the consecutive weak data, markets quickly revised their expectations for Fed rate hikes. At the beginning of last week, interest rate futures priced in a 70% chance of a rate hike in October. After the PCE inflation data, that probability dropped to 35%, and following the non-farm payroll release, it plunged further to 18%. Indeed, the latest data have given the Fed under Chair Powell the option to hold rates steady before the midterm elections.
However, this set of figures does not change the overall picture of inflation declining too slowly, and the inflation level remains far from the policy target. In the coming months, inflation needs to continue slowing for monetary authorities to fulfill their commitment to controlling inflation and thus halt rate hikes. The author believes the likelihood of a rate hike in October has dropped significantly, though he still maintains that there are likely two more rate hikes before March next year.
The yield on US 30-year Treasury bonds has surged relentlessly, breaking through successive levels and reaching a new high not seen since 2002. The entire yield curve has shifted upward, and the spread between 10-year and 2-year Treasury yields has further narrowed, bringing the yield curve closer to inversion. Corporate credit markets are also highly volatile. The CDS prices of certain AI hyperscale cloud service providers have approached the levels seen in Chinese property developers' USD bonds just before their defaults. Bond market warning signals are flashing frequently.
There are multiple reasons behind bond market turmoil: the US-Iran conflict appears endless, with Brent crude prices surpassing USD 100 per barrel again; US inflation has not cooled sufficiently, and the Powell-led Fed has responded with hawkish rhetoric, potentially leading to stronger-than-expected rate hikes; the interest rate differential between the US dollar and currencies like the yen and euro is narrowing, prompting capital outflows from dollar-denominated assets. However, rate hikes cannot stop gasoline and diesel prices from rising, and fluctuations in interest rates and the dollar are cyclical factors.
The author believes structural factors deserve greater attention: US liquidity has shifted from abundance to scarcity. Yields across the entire US Treasury curve have risen to levels not seen since before 2008, indicating that the ultra-loose monetary environment created by two rounds of QE has completely vanished. Although the Fed's balance sheet remains much larger than its 2008 level, so has the size of the economy, demand for funds, and market leverage. The frenzy in US stocks is approaching the levels seen during the Dotcom era.
The first reason for the structural decline in market liquidity is the persistent annual fiscal deficit. It took the US over 200 years to accumulate its first trillion dollars in federal debt, but now it generates a trillion dollars in new debt every seven months. The Treasury's annual interest payments have already exceeded the sum of the federal defense and education budgets, and Uncle Sam shows no intention of slowing down its spending spree. The market is voting with its feet, signaling to the government that this path is unsustainable.
The second reason is that tech giants, having generated massive profits in recent years, used to spend them on stock buybacks. But the AI arms race means even the landlords are running out of reserves. Free cash flow is beginning to fall short, prompting hyperscale cloud service providers to issue debt—not only USD bonds but also EUR and even CHF bonds. Smaller firms are raising funds from private credit and infrastructure funds, locking up short-term funds that would have otherwise stayed in banks or money market funds into long-term investments. The AI industry is expected to face a funding gap of at least USD 3.5 trillion over the next three years, inevitably competing with Treasury bonds for capital.
The third reason is de-dollarization and de-Treasurization. Since the US froze Russia's assets, countries and high-net-worth individuals have grown concerned that their dollar assets could be 'weaponized,' leading to a quiet reallocation of funds. Overseas capital has long been a crucial source of support for US Treasuries.
The fourth reason is the Fed's 'whatever it takes' stance on inflation control, which has driven up the Treasury's borrowing costs. With long-term bonds under pressure, Beneset shifted this year's issuance focus to short-term debt. However, the Fed's hawkish rate hikes have also pushed up short-term borrowing costs. The policy objectives of the Fed and the Treasury are fundamentally at odds.
Media have focused on Treasury yields breaking psychological thresholds, but the author pays little attention to such levels and instead believes this is a 'boiling frog' process. The trend of liquidity shortage is already established; it's just unclear when and how it will erupt. The bond market resembles a gas station filled with vapor—only the timing of the spark is unpredictable. A break in the most fragile link in the capital market—such as a failed large-model IPO or a downgrade in a major company's credit rating—could trigger a chain reaction.
The author emphasizes that the rise in US Treasury yields from near zero to over 5% represents a massive shift. The last time such a dramatic change occurred was in the early 1980s under Fed Chair Volcker. None of today's star analysts on Wall Street experienced that brutal period, nor has the author. Investors should proceed with caution.
Despite bond market turbulence, US equities appear relatively calm. The profitability of large tech giants remains strong, which is the biggest difference from the Dotcom bubble era. The S&P 500's PE ratio is somewhat higher than historical averages but not crazily expensive. It is worth noting that earnings are concentrated in tech companies and banks, and their profit outlooks depend heavily on AI, including extensive 'circular prosperity.' Over the past month, AI-related stocks have driven gains, while other sectors have borne the pressure of rising funding costs.
Finally, a tweet shared on X by Charlie Bilello: 'NVIDIA (US.NVDA) has a market cap of USD 5.4 trillion, over USD 2 trillion more than the combined market cap of all companies in the Russell 2000 Index. This seems crazy—until you realize that NVIDIA earned USD 193 billion in profit over the past year, while the Russell 2000 companies collectively lost USD 13 billion.' There are several layers to this statement; readers are invited to reflect on them.
This week features few major data releases, and markets remain focused on the bond market. Key points to watch: 1) the minutes from the FOMC's September meeting, especially members' views on future inflation control and balance sheet management; 2) the ECB's September meeting minutes, offering a glimpse into the upcoming rate hike path. Also, monitor the US consumer confidence index. David Tao
*This week's article presents the author's understanding and views on the economy, policy, and markets. It is personal opinion and not investment advice or solicitation.
*Articles published in Economic Times, whether signed or unsigned, represent the authors' personal opinions and do not reflect the position of Economic Times. Economic Times serves as a platform for free expression.
US personal consumption, adjusted for inflation, expanded by 0.6% month-on-month in August—the fastest spending pace since the end of 2024. Despite rising living costs, demand for big-ticket items such as automobiles and furniture remains strong. Robust stock markets and a vibrant labor market continue to support economic activity. Second-quarter GDP annualized growth was revised upward from 1.5% to 2.2%, and the Atlanta Fed's GDPNow model suggests current US economic growth is around 5%.
The market's more closely watched PCE index rose 0.3% month-on-month and 3.4% year-on-year, in line with expectations. The core PCE index rose 0.2% month-on-month and 3% year-on-year, showing inflation momentum weaker than expected. Since the Fed's rate hikes cannot alter geopolitical situations or oil supply, investors are focusing more on core inflation data. Non-farm payrolls in September increased by only 29,000, far below analysts' forecast of 82,000, and the figures for the previous two months were also downwardly revised. Single-month employment data are generally volatile and should not be used to determine a trend, but at the very least, they provide the Fed with the possibility of pausing rate hikes and observing the situation.
In response to the consecutive weak data, markets quickly revised their expectations for Fed rate hikes. At the beginning of last week, interest rate futures priced in a 70% chance of a rate hike in October. After the PCE inflation data, that probability dropped to 35%, and following the non-farm payroll release, it plunged further to 18%. Indeed, the latest data have given the Fed under Chair Powell the option to hold rates steady before the midterm elections.
However, this set of figures does not change the overall picture of inflation declining too slowly, and the inflation level remains far from the policy target. In the coming months, inflation needs to continue slowing for monetary authorities to fulfill their commitment to controlling inflation and thus halt rate hikes. The author believes the likelihood of a rate hike in October has dropped significantly, though he still maintains that there are likely two more rate hikes before March next year.
The yield on US 30-year Treasury bonds has surged relentlessly, breaking through successive levels and reaching a new high not seen since 2002. The entire yield curve has shifted upward, and the spread between 10-year and 2-year Treasury yields has further narrowed, bringing the yield curve closer to inversion. Corporate credit markets are also highly volatile. The CDS prices of certain AI hyperscale cloud service providers have approached the levels seen in Chinese property developers' USD bonds just before their defaults. Bond market warning signals are flashing frequently.
There are multiple reasons behind bond market turmoil: the US-Iran conflict appears endless, with Brent crude prices surpassing USD 100 per barrel again; US inflation has not cooled sufficiently, and the Powell-led Fed has responded with hawkish rhetoric, potentially leading to stronger-than-expected rate hikes; the interest rate differential between the US dollar and currencies like the yen and euro is narrowing, prompting capital outflows from dollar-denominated assets. However, rate hikes cannot stop gasoline and diesel prices from rising, and fluctuations in interest rates and the dollar are cyclical factors.
The author believes structural factors deserve greater attention: US liquidity has shifted from abundance to scarcity. Yields across the entire US Treasury curve have risen to levels not seen since before 2008, indicating that the ultra-loose monetary environment created by two rounds of QE has completely vanished. Although the Fed's balance sheet remains much larger than its 2008 level, so has the size of the economy, demand for funds, and market leverage. The frenzy in US stocks is approaching the levels seen during the Dotcom era.
The first reason for the structural decline in market liquidity is the persistent annual fiscal deficit. It took the US over 200 years to accumulate its first trillion dollars in federal debt, but now it generates a trillion dollars in new debt every seven months. The Treasury's annual interest payments have already exceeded the sum of the federal defense and education budgets, and Uncle Sam shows no intention of slowing down its spending spree. The market is voting with its feet, signaling to the government that this path is unsustainable.
The second reason is that tech giants, having generated massive profits in recent years, used to spend them on stock buybacks. But the AI arms race means even the landlords are running out of reserves. Free cash flow is beginning to fall short, prompting hyperscale cloud service providers to issue debt—not only USD bonds but also EUR and even CHF bonds. Smaller firms are raising funds from private credit and infrastructure funds, locking up short-term funds that would have otherwise stayed in banks or money market funds into long-term investments. The AI industry is expected to face a funding gap of at least USD 3.5 trillion over the next three years, inevitably competing with Treasury bonds for capital.
The third reason is de-dollarization and de-Treasurization. Since the US froze Russia's assets, countries and high-net-worth individuals have grown concerned that their dollar assets could be 'weaponized,' leading to a quiet reallocation of funds. Overseas capital has long been a crucial source of support for US Treasuries.
The fourth reason is the Fed's 'whatever it takes' stance on inflation control, which has driven up the Treasury's borrowing costs. With long-term bonds under pressure, Beneset shifted this year's issuance focus to short-term debt. However, the Fed's hawkish rate hikes have also pushed up short-term borrowing costs. The policy objectives of the Fed and the Treasury are fundamentally at odds.
Media have focused on Treasury yields breaking psychological thresholds, but the author pays little attention to such levels and instead believes this is a 'boiling frog' process. The trend of liquidity shortage is already established; it's just unclear when and how it will erupt. The bond market resembles a gas station filled with vapor—only the timing of the spark is unpredictable. A break in the most fragile link in the capital market—such as a failed large-model IPO or a downgrade in a major company's credit rating—could trigger a chain reaction.
The author emphasizes that the rise in US Treasury yields from near zero to over 5% represents a massive shift. The last time such a dramatic change occurred was in the early 1980s under Fed Chair Volcker. None of today's star analysts on Wall Street experienced that brutal period, nor has the author. Investors should proceed with caution.
Despite bond market turbulence, US equities appear relatively calm. The profitability of large tech giants remains strong, which is the biggest difference from the Dotcom bubble era. The S&P 500's PE ratio is somewhat higher than historical averages but not crazily expensive. It is worth noting that earnings are concentrated in tech companies and banks, and their profit outlooks depend heavily on AI, including extensive 'circular prosperity.' Over the past month, AI-related stocks have driven gains, while other sectors have borne the pressure of rising funding costs.
Finally, a tweet shared on X by Charlie Bilello: 'NVIDIA (US.NVDA) has a market cap of USD 5.4 trillion, over USD 2 trillion more than the combined market cap of all companies in the Russell 2000 Index. This seems crazy—until you realize that NVIDIA earned USD 193 billion in profit over the past year, while the Russell 2000 companies collectively lost USD 13 billion.' There are several layers to this statement; readers are invited to reflect on them.
This week features few major data releases, and markets remain focused on the bond market. Key points to watch: 1) the minutes from the FOMC's September meeting, especially members' views on future inflation control and balance sheet management; 2) the ECB's September meeting minutes, offering a glimpse into the upcoming rate hike path. Also, monitor the US consumer confidence index. David Tao
*This week's article presents the author's understanding and views on the economy, policy, and markets. It is personal opinion and not investment advice or solicitation.
*Articles published in Economic Times, whether signed or unsigned, represent the authors' personal opinions and do not reflect the position of Economic Times. Economic Times serves as a platform for free expression.
