The $300 Trillion Credit Bubble Is About to BURST!

Central bankers are in a state of panic as government bond yields are rapidly increasing across the globe, leading to emergency meetings. The primary concern is not the stock market but the credit bubble, and the fear that rising interest rates will cause it to burst, pushing the global economy into a recession. Central bankers believe they control the bond market, but the market's current behavior suggests otherwise, relentlessly driving interest rates higher. This poses a significant problem for governments that continue to spend, as higher interest rates will make funding more expensive and could force spending cuts, further slowing down an already decelerating global economy. The US 30-year Treasury yields are near their highest since 2007, with Japan's situation also playing a critical role.

The market is currently dictating terms to central bankers, as evidenced by the spike in two-year Treasury yields, which signals to the Federal Reserve that interest rates will need to rise. While the bond market often leads the Fed, there have been instances (e.g., 2001, 2008, 2011) where the Fed has resisted market expectations. The current crisis is exacerbated by oil prices and the Middle East conflict, impacting economic growth and fueling inflation. Unlike demand-led inflation, an energy shock leads to cost-push inflation, where consumer paychecks struggle to keep pace, forcing a reduction in spending. This dynamic has historically been a precursor to recessions, as seen in four of the last five instances. Gas prices and the Consumer Price Index show a strong correlation, indicating that rising fuel costs could soon translate to higher inflation.

Sustained high inflation, particularly when coupled with a weak labor market, is a classic recipe for recessions. However, unlike demand-led inflation which typically sees wage growth, the current situation does not. Average hourly earnings are not keeping pace with rising gas prices; in fact, they are trending downwards. This suggests that consumers cannot afford higher prices, implying that current inflation is likely transitory. Central bankers at the G7 meeting acknowledge the risk of less growth and more inflation, leading to stagflation rather than a full-blown recession, at least for now. However, if the labor market breaks, the situation could worsen. The ability of central banks to react to future economic downturns is severely limited, especially with already low policy rates and massive government deficits. The potential for a future financial crisis due to a credit bubble implosion is a looming threat.

The UK is experiencing early signs of this crisis, with employers cutting jobs at the fastest rate since the pandemic, indicating weakening demand for workers. All eyes are now on Japan, as its interest rate movements tend to influence global trends. Japan's economic growth could prompt the Bank of Japan to hike rates, despite their historical reluctance due to fears of triggering a recession. Rising inflation and yields in Japan are pressuring the BOJ to act, but their past actions, such as the ECB's rate hikes before the 2008 crisis, show the risks involved. Japan's government plans for increased debt issuance to fund gasoline subsidies are further unsettling bond markets, as deficit spending for tax cuts could exacerbate inflationary pressures. This could lead to a 'prolonged recession' or 'rolling financial crisis' due to mounting debt and shrinking policy buffers.

The market widely believes that rates will skyrocket, with long-dated US Treasury yields recently breaching 5%, the highest since 2007. Investment banks like Citigroup even suggest a potential 5.5% target for the 30-year Treasury bond. However, a critical historical chart challenges this consensus: the relationship between average hourly earnings and 2-year Treasury yields. Historically, periods where yields surged significantly above wage growth have always been followed by a sharp reversal in yields, bringing them back in line with slowing wage growth. Since 2022, despite spikes in yields, average hourly earnings have continued to trend downwards, suggesting that yields are poised to follow suit. This implies that the market's current expectation for perpetually higher rates might be misguided. If rates indeed start to come down, it presents an opportunity for investors to consider government bonds or potentially see a significant rally in the stock market (S&P 500 hitting 8,000).