Could A Breakdown In Bonds Break The Stock Market? Bessent Pressures Bank Of Japan For A Stronger Yen Would Trump Sue The Fed? "We are spending around 600 billion a month, and the US political class has been unwilling to meaningfully cut spending to address our debt issues. Obviously the hope is that we grow our way out of 37 trillion. By the way, we tipped over 37 trillion last Monday, and so we're on the fast march towards 40 trillion in debt. And at the current deficit pace, that's either one, maybe two years out." —David McAlvany * * * Kevin: Welcome to the McAlvany Weekly Commentary. I'm Kevin Orrick, along with David McAlvany. David, the stock and the bond market are interesting. The way a broker looks at the stocks and bonds usually is that if the stock market is high and starts to break down, that money usually will move into bonds, yields will fall, bond values will rise. That actually is what we would consider a relatively healthy move. But if the bond market is already high and it breaks down and pulls the stock market with it, that creates an anomaly, doesn't it? David: It does, and it was interesting to hear Goldman Sachs in May of this year comment that the reason you should have gold in your portfolio is because the relationship between stocks and bonds was breaking down, and both were moving lower. Of course, that was apropos if you're thinking the April timeframe. But they're observing this and it should not happen that both move the same direction. You should get some benefit, and if bonds are not a safe haven, gold remains a go-to asset. Again, Goldman Sachs, late May. Kevin: Right. And it's good to think of the bond market like a seesaw or a teeter-totter. If interest rates rise, the value of the bonds go down. If interest rates fall, the value of the bonds go up. Right now, Japan, Germany, France, the United States, the UK, Canada, right now, you've been talking about the possibility of interest rates going up, bonds going down. David: Yeah. With those countries, what they have in common at the moment— Again, it's a short list: Japan, Germany, France, the US, UK, Canada, Australia. Kevin: Can you make an acronym out of that, Dave? David: I think you can. It would be JGFUUCA. Kevin: So, that's a little different than BRICS, right? David: It is different than BRICS, but everything gets an acronym eventually. Kevin: Right. David: That list is not exhaustive, but there is a common characteristic. Kevin: And the yields are getting ready to break out to the upside, possibly. David: Yields are threatening to break out to the upside. You survey the charts of those countries, particularly their long bonds. The yields are bumping up against higher levels. Each time they test the upper bound, there's an increased probability of a break, a break higher. And of course, the inverse of yield is price. The price of those bonds paints the inverse picture, and it looks like a tap dancer on thin ice. Lots of activity at one level for an extended period of time, threatening to break down in price. Kevin: What does that mean? David: There is a reasonable shot at a bond bear market that negatively impacts a huge part of the developed world, and the developed world economy with, again, those epicenters being notably Western. Call it another leg in a global bond bear market. We're perhaps finishing the intermission after watching the first act unfold between 2020 and 2023. Kevin: Okay, but you stressed that it's the western side of this. On the eastern side, are they lowering rates? David: Notably different, you see a trend in the opposite direction where yields are going lower. South Korea, Singapore, and China stand out. Again, yields trending lower in what Trump could only dream of here in the United States. He'd love to see lower rates. We're getting the opposite. Don't get me wrong, nominal yields in many of the BRIC countries are orders of magnitude higher than the short list just mentioned. Kevin: Some are double digit, I think. David: Yeah, Brazil and South Africa are both in the double digits. The contrast and the concerning element for the—what do we call it? JGFUUCA— Kevin: You're going to have to be careful how you pronounce that. David: I know. It's going to be an acronym. It'll be adopted. —is that most of them have been in the privileged position of borrowing a lot of money at very reasonable rates. The concern centers on a move to levels in interest rates that make current debt levels unsustainable. We already have fiscal pressure in the US from rolling over short-term debt at considerably higher rates. The UK is very much in that same boat. Kevin: We do consider Treasury's still a very safe asset if it's on the short end of the curve, right? David: Absolutely. We think of the Treasury market as a safer place to allocate capital, and that's particularly so at the short end of the yield curve, two years and under. That would be true of a couple of those countries mentioned, too: Germany, Japan, and the US. They make up the top three in terms of most-liquid government bond markets, not necessarily in that order. Yet the stress shows up in the charts even for these very liquid markets. And I think these bond markets may hold the key for the equity markets. Kevin: The equity markets right now are, again, at all-time highs. The Buffett ratio is very high. We're coming into the week, Dave, that we've talked about 18 years, now, in a row: Jackson Hole. And usually there's announcements at Jackson Hole that make a difference on not just the bond market, but the equity market. David: Yeah. This soirée has been taking place since 1978. It was originally sponsored by the Kansas City Fed, and the invites would go out to your top central bankers from around the world. It's a mix of monetary and fiscal policymakers from around the world. The Federal Reserve in the Wyoming mountains, notable folks are showing up as we speak, and these decision makers gather to discuss white papers, debate appropriate actions in the current context. It is the Global Geek Squad. On occasion, the trends set from Jackson Hole have significant market implications. I think of Ben Bernanke's 2010 hinting at QE2, which was very encouraging for equity speculators. 2012 again, he did the same thing, hinting at QE3. And markets are looking for reasons to be enthusiastic or afraid, usually looking for reasons to be enthusiastic. Kevin: And that's why the timing of this might be really interesting. You didn't say that yields are definitely breaking up to the upside. You said that we're on thin ice. I remember, Dave, walking to junior high every day. In the winter time, the lake would ice over and it would cut the route quite a bit. But if you got out a little bit too thin on the ice on the spring, usually one of the junior highers ended up falling— David: Went swimming. Kevin: —yeah, falling through. So, we're on thin ice. You're not saying it has to happen right now? David: No. In fact, probabilities are that we get a rate cut of 25 basis points—over 80% probabilities as the market's currently pricing it in September. That, again, is when the market finds something unexpected. If they're expecting a rate cut of 25 basis points, they don't get what they want, there's a temper tantrum that's thrown. Just because yields have risen and threatened to break out doesn't mean they will. But having notable bond markets around the world tap dancing, if you will, as they are in thin ice, that's what you see in current pricing. At the same time, equity markets are at, as you mentioned, egregiously overvalued levels. Kevin: Right. David: And it leaves a few scenarios open. If you looked for an autumn sell-off in equities, you could see some benefit going to those vulnerable-looking bond markets, helping with the reversal in yields to lower levels as money migrates to more liquid fixed income positions out of risk assets. That's one scenario. Kevin: Yeah, that can actually really help a bond market where the yields are rising, is a stock market breakdown. But going to where we started, there are times when the bond market breaks down and the stock market breaks down. That's when it's dangerous. David: That's what Goldman Sachs was noting— Kevin: Yeah. David: —in May about the behavior of both markets in April. The more dangerous potential outcome is that bonds move first, break down—again, that's prices lower and yields higher—and fixed income sets the tone for risk assets. Then an equity move lower in that context would not necessarily benefit fixed income, and the trading tone already negative, the price action presenting another way to lose money, going from the equity frying pan into the fixed income fire, there's no way to preserve value. Kevin: Okay, so it is good to watch rates. I was just laughing. I joke about how you will easily read a 650-page book on interest rates, and I typically won't, Dave. I have other things that I like to read. But sure enough, on your shelf there is a, what is it, 650-page book on interest rates. The reason you read those books is because this really is important. David: Yeah. Homer and Sylla wrote the tome. For those less interested in interest rates, maybe The Price of Time, our guests earlier this year. Kevin: Yeah, that was a good book. And it was shorter, by the way. David: Yeah, by half. It was only 300 pages, but very readable. Kevin: So, again, if bonds move first, along with currencies, that could be tough on equities because the equities are so high right now. David: Yeah. And I think that's the combination we've been lingering on for some time. As we've said repeatedly all year long, watch the bond market. Watch the currency markets. If bonds move first along with currencies and the tone's set in equities, it would just be a terrible one,