The challenge of public debt and the new economic paradigm
The increase in sovereign bond yields and the tension between fiscal and monetary policies mark a scenario of global uncertainty.
Quick Look
- Government debt yields reach critical levels as US Treasury interventions fail to contain funding costs.
- The historical correlation between bonds and stocks is upended by the rise of AI companies.
AI-generated summary
Why It Matters
The US 10-year bond is approaching a 5% yield. The US economy has a fiscal imbalance of 6%.
Public debt yields are right now a mastodon dancing on a wire. The risk line, which in the US 10-year bond is 5% and in the German one at 3.5, is approaching without some of the measures that have proven effective in the past offering guarantees of a solution. The interventions of the American Treasury on the yen and on its own debt are not altering the patterns. The cost of sovereign financing continues to grow.
There are several unknowns to be resolved. The first lies in the behavior of the stock markets. Such a rapid rise in bond yields usually leads to a fall in stocks. The simplest explanation is that the higher the interest rate offered by "risk-free" states, the higher the interest rate that companies have to offer to finance themselves. The increase in the cost of credit compromises profits. However, the results of AI companies and their derivatives, which represent more than half of the American stock market, are disrupting this historical correlation. Until when?
The answer depends on how the paradigm shift that is occurring after Donald Trump's second coming to power is adjusted. Much to his chagrin, the Federal Reserve chair sympathetic to his administration appears determined to raise interest rates, as is the ECB. The inflation that is generating geopolitical instability leaves no other way out.
However, the effect will also be limited if only a few, the central bankers, do their part of the work. The other corresponds to governments, which must reduce the deficit, and this is where the story changes. The United States economy has a massive fiscal imbalance of 6%. Its containment implies a cooling of the GDP that Trump is not willing to accept in an election year. And not only.
Treasury Secretary Scott Bessent has downplayed inflation and put all his focus on growth. Only with this can the interest on the debt be paid. Central bankers fear that we are entering an era of fiscal dominance, in which states do not mind taking on debt to cover the inefficiencies of their populist policies. Trump is clear about it, but not only him. The European extreme left shares a roadmap. The revolution arrives.
Open Questions
- How long will the correlation between bonds and stocks last?
- How will fiscal dominance affect long-term inflation?
