Good morning – What a weekend. Unscripted events are increasingly becoming the norm so let’s talk about the upcoming fiscal chaos.
Last Fall I released a video laying out a dire forecast for Western governments. It looks like I was a year early.
Once the Fed began to raise rates in Spring ‘22 I knew big trouble was ahead. Economists, Wall Street analysts, and hedge fund managers use complex models and trading algorithms to predict market behavior but the stark reality staring menacingly back at us like a financial Cthulhu is overwhelming debt.
Like many others, I knew raising interest rates to fight inflation so high so fast would trigger the debt bomb and so it did. In a flash, bankers who had assumed low interest rates would continue in perpetuity saw balance sheets turned upside down. Seemingly overnight, assets became liabilities, and a similar effect would ripple through the entire global economy.
Thereafter, Commercial Real Estate (CRE), government debt (Treasuries), and bank loan books came under pressure. What followed relatively quickly was the collapse of the UK Gilt market and the resignation of Prime Minister Liz Truss who was Prime Minister for barely 90 days.
About 6 months later in Spring ‘23 came the collapse of Silicon Valley Bank (SVB) followed by Signature, One Republic and other regional banks, which forced the US Treasury to guarantee all depositors regardless of FDIC mandates. Later that October, a flare up struck US government debt markets when yields surged above 5% in the 10 Year Treasury around the same time of the shocking Hamas attack in Israel.
Then suddenly things calmed down, at least in mainstream discourse. No one worried about the banking crisis anymore, CRE mark downs faded into the background, and a new narrative emerged that the US economy was booming and a slowdown in China and Europe were manageable. Inflation fell, consumers spent, yields tapered, and after a brief correction the stock market soared to new all time highs.
The US economy feels qualitatively different, a sentiment shift is palpable.
Today, the US economy feels qualitatively different, a sentiment shift is palpable. Of course, none of the aforementioned problems went away and new ones are piling up. In recent weeks, unemployment has worsened, housing prices are falling, and whispers of recession are getting louder, once again.
The global economy appears to be in sharp decline. China is combating a pricked property bubble, Japanese banks are failing and the Yen is tumbling like a manhole cover from the sky (see below). Europe is already in recession and despite ECB hikes inflation continues to suffocate average people stuck paying higher energy and grocery costs.
At the same time, Western governments from Berlin to DC are in crisis. Euroskeptic parties across the continent outperformed in European parliamentary elections showing frustration with the EU is boiling over. Election results could not have fared worse for ruling parties either. Leftist parties successfully secured victory but now preside over extremely fragile coalition governments, deteriorating fiscal nightmares, and escalating social tensions.
Across the Atlantic, America is grappling with a leadership crisis of its own, and perhaps worse post-Trump assassination attempt. President Biden’s disastrous debate two weeks ago confirmed the worst suspicions of Americans whose confidence in the US Government (USG) was already shaky. While there is some optimism that electing Donald Trump can right the ship, a darker fear is beginning to seep in that something disastrous is coming regardless of who is elected.
A darker fear is beginning to seep in that something disastrous is coming regardless of who is elected.
And so it is. Market forces are very likely to break western governments this Fall. If elected, Donald Trump’s fiscal plan is not meaningfully different from Liz Truss’ plan two years prior, neither is Keir Starmer’s Labor policies or the coalition governments in France and Germany. All plan to spend, spend, spend and spend some more and none are prepared for violent market reactions when they do.
Bond markets will not abide this time. There is simply too much debt, recessionary forces are too strong, and creditors both domestically and internationally are worried, if not spooked.
What I am suggesting is that a financial Cthulhu is knocking at the door and something disastrous is about to happen in public finances. The ironclad assumption that fiscal authorities are immune from market forces is dangerous. Such an assumption has ensnared Western governments in a financial choke hold of their own making and their only plan is to tighten the noose.
Stay liquid, stay alert.