Hey There Income Hunter,

It seems like many disgruntled employees are talking about strikes these days.

Well, add US Treasury bond buyers to that list.

The second week of each month is the week the Treasury issues 3-year, 10-year and 30-year bonds … 

Yesterday, there was a double, with both 3-year and 10-year on the block.

Neither went well.

In fact, the 10-year was one of the worst auctions in history as the yield awarded was nearly .03% higher than where it was trading in the market at the 1 p.m. auction time. 

Check out the slide in the iShares 25+ Treasury Maturity Bond ETF (TLT) after the announcement of the results … 

This has been a major worry for markets, especially because quantitative tightening is a policy tool that has the Fed selling an additional $95bn bonds a month when no-one seems to want them. 

Today, we’ll take a look at why there aren’t any buyers at such lofty interest rates and what it means for markets.

US Bond Market Bubble Bursting

When the dollar was the only game in town, foreign countries scooped up US Treasury bonds like they were Wonka golden tickets.

The bonds would earn foreign central banks interest while they were a store of value, which could be used to pay for all their energy needs. 

Now, with an energy crisis and high inflation, holders of these once-loved bonds are selling them at a fast pace to pay for much more expensive energy. And energy that can’t be paid for in dollars in many instances, since the Russian invasion and sanctions put on Russia by the West. 

The sudden shift, which has crushed economies AND raised interest rates

The double-whammy has created a global crisis for China, Japan and Germany who together hold the greatest amount of US dollar assets (mostly bonds) in the world.

The graph below shows the net international investment position (NIIP), which measures the gap between foreign assets the US holds versus the US assets that foreigners hold.

Now, this is important to understand …

The US never accumulated other countries’ assets because we have been a debtor nation for 30 years. 

That put us in a situation where we needed investors to finance our deficits and this has soared to -74%!

To put this in numbers, Japan and Germany hold approximately $18 trillion in US dollar assets, with bonds being a large percentage of those holdings. 

Their need to sell them as they have shifted to debtor nations due to the oil crisis has a couple of major implications for the markets…

Japan, in particular, is a major holder of US Treasury bonds (UST), and a weaker Japanese yen (JPY)  versus the USD, drives the UST yield higher, as you can see below …

Notice how big this trade has already become and how much of a driver it has been for higher US interest rates. 

This market dynamic will likely continue until either Japan runs out of USTs to sell or UST yields break the housing market, the US economy, or the US government, forcing the Fed back into quantitative easing. 

The second implication has to do with the US dominating the world’s equity market cap …

Chart sourced from:SIFMA

Notice the US equity market cap at 41% of the global total. This is over 2x bigger than the US share of global GDP.

So, Japan and the EU will need to sell US stocks to raise US dollars to support their own currencies to finance their energy-driven current account deficits … 

In other words, when they both had access to cheap Russian energy they were able to manufacture goods and sell them abroad, and the revenues would finance their budget … 

Now, they can’t afford to manufacture goods at the price they are paying for energy so they operate at a net loss.

The end result …

Foreigners are selling US stocks and bonds to finance their deficit caused by the energy crisis. 

Bring It Home

The signposts for a meltdown are still not in place … 

The financial conditions have loosened up in the recent relief rally and since then sentiment has lifted.

There is still over $2 trillion dollars parked at the Fed, which is a cushion that could absorb much of QT, so it may take some time for QT to absorb excess cash on the sidelines.

This all says to be patient and not get too enthusiastic about a trade to new lows. 

This morning’s CPI is big, but the market needs a bigger event that actually forces real selling in order to break the consolidation trade. 

The bond market will provide the signal that it is close at hand …

Join Andrew Giovinazzi and I LIVE this Thursday at 7 p.m. to see how we’ll trade it.

Live and Trade With Passion My Friend,

Griff