Bond market going to burst stock bubble? The bond market is sending the same warning it sent in 1873

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via MarketWatch:

When it comes to stock-market downturns, listen to the Bible. Even if one is coming, “of that day and that hour knoweth no man,” not even “the angels which are in heaven.”

But one is surely coming, and the unraveling of the long-term bond market is raising the chances that one is imminent.

It is already absurdly obvious that we are in a massive stock-market bubble. Former Federal Reserve governor Bill Dudley just pointed out many of the signs, which will likely come as no surprise to regular readers of MarketWatch but which are worth repeating.

While Dudley listed a number of different issues, they boil down to three big ones. First, stock-market valuations are already crazy by any number of measures. Second, the entire artificial-intelligence financial boom is now in the kind of classic Ponzi-style loop that always happens in financial manias, and which has always been followed by a downturn or worse. And third, the rise in long-term interest rates in the U.S. and around the world are exactly the kind of thing that could burst the bubble.

The interest-rate argument is most timely. It looks increasingly like the U.S. Treasury, the global lender of last resort, is losing control of long-term rates. The alleged Treasury “buyback” program that sparked a brief rally was far less than it seemed; it involved trivial sums of money and no new money.

And the bond rally is already over: By early Thursday, the yield or interest rate on the benchmark 10-year Treasury note was already back to where it was before the announcement.

The Bond Market Is Sending the Same Warning It Sent in 1873
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The single biggest engine of the US economy right now is the massive buildout of AI infrastructure. We’re watching a frontier boom for a new age of wild capitalism, except steam engines and steel rails have been replaced by server racks and microchips. Columbia Business School’s Stijn Van Nieuwerburgh goes so far as to argue that without this enormous flow of money, the US would already be in a recession. By his estimate, AI infrastructure investment has reached roughly 2.8% of GDP, bigger than the famous 19th-century railroad boom, and this debt-fueled rocket keeps climbing at full throttle.

Investors are starting to wake up to the financial risks of this AI spending spree, and they have a deep well of history to draw on. Like every transformative technology before it, AI has to be financed with borrowed money long before it produces any real return.

150 years ago, the financier Jay Cooke ran a similar campaign financing the Northern Pacific Railroad. It ended badly, not because railroads were a bad idea, but because the bonds funding it traded at steep discounts for months before Cooke’s banking house finally collapsed, triggering the Panic of 1873 (contemporaries called it the Great Depression of the 19th century). As Alberto Gallo of Andromeda Capital Management points out, history is full of worthy projects that weren’t worthy investments: they benefited the wider population years later but never delivered adequate financial returns to their original backers, especially lenders.

Today’s debt-financed AI buildout isn’t necessarily headed for the same reckoning, but credit markets have always sensed trouble before equity markets do. In 1873, bond spreads were also flashing warning signs long before newspapers ran their first panic headlines. Credit markets are doing the same thing today: Barclays analysts note that credit spreads for the major AI players have widened noticeably in recent weeks. Meanwhile the S&P 500 keeps hitting fresh record highs, opening up the classic gap between stock-market optimism and the harsher truth of the credit market. It’s not yet clear whether this is temporary or the start of something bigger, but the current turbulence leaves both readings open.

The Message is Clear: They’ll Debase Before They’ll Let Bonds Break.

  1. The most critical issue for policymakers is maintaining the bubble in sovereign debt. The reason for this is that these bonds are the bedrock of the current debt-based financial system, and their yields represent the “risk free” rate of return against which all risk assets (stocks, real estate, etc.) are valued.

  2. Because the crash triggered by the economic shutdowns in 2020 was both extremely rapid (a matter of days) and violent (a 20% decline in less than 20 trading sessions), it forced policymakers to reveal their “entire playbook” for dealing with crises. This playbook consists of three strategies:

    1. Cutting interest rates aggressively to control bonds on the short end.
    2. Printing money and using it to buy bonds on the long end.
    3. Printing money and using it to buy junior debt securities (mortgage-backed securities, student loans, commercial paper).

In this context, the recent move by Treasury Secretary Scott Bessent makes perfect sense. Yields on the long end of the Treasury curve were in danger of breaking out to the upside, which would threaten the “Everything Bubble” including stocks.

This was a critical issue. Remember, ~45% of household wealth is tied up in stocks. And a market meltdown, triggered by a spike in Treasury yields is the last thing the Trump administration needs with the midterm elections approaching.

To address this, the Treasury announced, outside its normal quarterly schedule, that it will be at least doubling the size of its buyback operations for longer-dated government debt, from $2 billion up to a minimum of $4 billion per operation, starting September 9. The move covers Treasuries from the 10-year out to the 30-year sector, and it runs through the current refunding quarter, which ends November 4.

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