One of the best posts. The mechanics are persistent budget dificits (themselves fueling money creation when spent) creating higher issuance which if done at the short end is creating close to 100% safe asset collateral which, in turn, fuels credit and more money creation. It's a cycle - for some vicious, for others virtuous - which is hard to get out of.
Now, budget deficits are associated with weak growth. But, as you say, we have strong NGDP growth. This extreme fiscal largesse is matched by a relatively accomodating monetary policy via all kinds of liquidity interventions and tweaks - which is associated with economic downturns or early stages of real GDP growth . But we are in the late stage of the cycle. From a policy PoV we are looking at the equivalent of a Texas hedge: late stage high NGDP growth with additional support by loose fiscal and monetary policy. This is best seen innthe remarkable yield of the 10Yr UST of 4.7% which long terms has matched NGDP growth (now around 7%). It is a symptom of how loose policy is, not a driver.
You are making the core point: either NGDP falls or the 10 yr UST yield rises. The dispersion of consequences of each scenario couldn't be greater. High dispersion of outcomes, in turn, is a sign at major economic turning points.
Spot on Michael and timely article. The House of cards is starting to buckle around Besant as rising yields show. The interventions I suspect will continue until Morale improves !!!. Do you recommend to still be in commodities at this stage or is cash/bonds a better play? Thanks Sebastian.
Sadly the Fed seems to be making it up as it goes alone. Their commentary varies from bank reserves are too high (last Fall) to bank reserves dont matter, to now bank reserves about right. They are plainly crucial for stability of repo markets. Watch this space closely. Pressures should build
Do you feel the higher nominal GDP growth will be a factor of higher real GDP or higher inflation rate? Also, if one were to assume that AI will lead to higher productivity (and therefore price deflation), could that potentially offset the inflationary effect that the Fed might create via artificially purchasing US government bonds? What would that imply for US stock markets?
Secondly, on your statement:
"The more repo liquidity the Fed supplies, the more that bank balance sheets and money supply expand — and the greater the risk that NGDP and main-street inflation accelerate"
This would mean that there is a lot of money supply in the market -- could this imply higher potential asset/equity prices as this liquidity moves into markets? How would you weigh this against your indications that we are in a downward trend in the capital cycle in your previous posts?
I am equivocal about inflation and see both sides, but whichever NGDP rises and bonds suffer. Equities are a better hedge than bonds but worse than commodities.
If there is monetary inflation you need monetary inflation hedges. Stocks could rise but the SPX/ GLD ratio will fall, even uf SPX/ TLT rises. Hence, GLD/ TLT is the monetary inflation trade
I have been a reader for some time now and appreciate your perspective in my investment strategy. I was hoping you could shed more light on this statement:
"If Nominal GDP in US rises, that leads to upward pressure on long term US treasuries."
I was curious as to why the Fed can't just buy long term US treasuries to create artificial demand and therefore suppress long term US bond yields. If there is rising yield pressure from foreigners selling US government bonds, and also the US government having to refinance their debt at increasing interest rates, it seems like an easy fix that the Fed would just buy the long term bonds to make up the demand shortfall. I guess the consequences would be that the US$ would depreciate on a relative basis to other currencies and possibly higher inflation due to pumping liquidity in markets?? If you were the Fed chair, what path would you likely choose given the pros and cons?
they could and did before under QE. My concern would be that QE policy showed that demand for safe asset duration was very sensitive to the policy itself. ie QE led investors to switch heavily into risk assets. Warsh claims he does not want a bigger B/S and Fed is aiming to shift its holdings from long to short.
Point forecasts are tricky, but this is my thinking.... yields are rising towards 6% for reasons cited. Alongside Fed/ Treasury are fighting this, but market forces are trying to flatten YC. Hence pressure at short end rising. At some point rising long yields will threaten economy and that point marks peak long yields. The bearish curve flattening will turn into a bullish steepening, probably when commodity markets peak. Is that 6m, 12m, 18m? Not sure...
Michael — could this be less "policymakers resisting an inevitable adjustment" and more a deliberate choice? Running NGDP hot via inflation and a weaker dollar is a classic way to shrink debt/GDP without spending cuts or default — financial repression, 2026 style. Do you read YVC as monetization gone wrong, or as a rational policy choice made with eyes open? And given the 1951 Accord parallel — how much runway does a deliberate repression strategy actually have before the bond market forces the issue, versus the decades of tolerance we saw post-WWII?
Peter, it could be. But to stop pressure on short end repo liquidity would have to be very carefully managed. I suppose the decision to halt RMP to mid-Sept implies they will restart them again in bigger size? YVC fits with Bessent's u/s of basis trade. The correlation of MOVE with future buybacks looks just too close to be random even if the spikes are bill purchases(?!). And, may be tge bond markets are smarter today than in 1950s/60s or at least less tolerant?!
One of the best posts. The mechanics are persistent budget dificits (themselves fueling money creation when spent) creating higher issuance which if done at the short end is creating close to 100% safe asset collateral which, in turn, fuels credit and more money creation. It's a cycle - for some vicious, for others virtuous - which is hard to get out of.
Now, budget deficits are associated with weak growth. But, as you say, we have strong NGDP growth. This extreme fiscal largesse is matched by a relatively accomodating monetary policy via all kinds of liquidity interventions and tweaks - which is associated with economic downturns or early stages of real GDP growth . But we are in the late stage of the cycle. From a policy PoV we are looking at the equivalent of a Texas hedge: late stage high NGDP growth with additional support by loose fiscal and monetary policy. This is best seen innthe remarkable yield of the 10Yr UST of 4.7% which long terms has matched NGDP growth (now around 7%). It is a symptom of how loose policy is, not a driver.
You are making the core point: either NGDP falls or the 10 yr UST yield rises. The dispersion of consequences of each scenario couldn't be greater. High dispersion of outcomes, in turn, is a sign at major economic turning points.
I'm wondering if a weak dollar and YCC or an early cousin of it in effect supports equities also even though it should add pressure to valuation.
Perhaps no one wants to own a bond anymore? Because of these long term implications
Spot on Michael and timely article. The House of cards is starting to buckle around Besant as rising yields show. The interventions I suspect will continue until Morale improves !!!. Do you recommend to still be in commodities at this stage or is cash/bonds a better play? Thanks Sebastian.
Hey Michael looks like people are talking about what you were saying with China crushing internal oil demand.
China steps in as Iran war drains US oil reserves to 40-year low | Iran: the Latest news https://share.google/7hmjAdQZPw2JkdzqM
Thanks. Yes it seens so. Saudi was the swing producer: China is now thecseing user!
Fed to Buy No T-Bills for August-September, and the Fed is steadily replacing its MBS runoff in exchange for adding T-bills. More tightening?
https://www.bloomberg.com/news/articles/2026-08-13/fed-to-buy-no-t-bills-for-august-september-amid-sluggish-funding
https://x.com/RealEJAntoni/status/20064144655210824
Sadly the Fed seems to be making it up as it goes alone. Their commentary varies from bank reserves are too high (last Fall) to bank reserves dont matter, to now bank reserves about right. They are plainly crucial for stability of repo markets. Watch this space closely. Pressures should build
Hello Micheal,
Do you feel the higher nominal GDP growth will be a factor of higher real GDP or higher inflation rate? Also, if one were to assume that AI will lead to higher productivity (and therefore price deflation), could that potentially offset the inflationary effect that the Fed might create via artificially purchasing US government bonds? What would that imply for US stock markets?
Secondly, on your statement:
"The more repo liquidity the Fed supplies, the more that bank balance sheets and money supply expand — and the greater the risk that NGDP and main-street inflation accelerate"
This would mean that there is a lot of money supply in the market -- could this imply higher potential asset/equity prices as this liquidity moves into markets? How would you weigh this against your indications that we are in a downward trend in the capital cycle in your previous posts?
I am equivocal about inflation and see both sides, but whichever NGDP rises and bonds suffer. Equities are a better hedge than bonds but worse than commodities.
If there is monetary inflation you need monetary inflation hedges. Stocks could rise but the SPX/ GLD ratio will fall, even uf SPX/ TLT rises. Hence, GLD/ TLT is the monetary inflation trade
Hello Michael,
I have been a reader for some time now and appreciate your perspective in my investment strategy. I was hoping you could shed more light on this statement:
"If Nominal GDP in US rises, that leads to upward pressure on long term US treasuries."
I was curious as to why the Fed can't just buy long term US treasuries to create artificial demand and therefore suppress long term US bond yields. If there is rising yield pressure from foreigners selling US government bonds, and also the US government having to refinance their debt at increasing interest rates, it seems like an easy fix that the Fed would just buy the long term bonds to make up the demand shortfall. I guess the consequences would be that the US$ would depreciate on a relative basis to other currencies and possibly higher inflation due to pumping liquidity in markets?? If you were the Fed chair, what path would you likely choose given the pros and cons?
Thanks for your posts!
they could and did before under QE. My concern would be that QE policy showed that demand for safe asset duration was very sensitive to the policy itself. ie QE led investors to switch heavily into risk assets. Warsh claims he does not want a bigger B/S and Fed is aiming to shift its holdings from long to short.
Hello Michael,
thank you very much for the article—it was a great read and, as always, thought-provoking.
What are your projections for the 10-year US Treasury yield, the federal funds rate, and core inflation in the US a year from now?
Point forecasts are tricky, but this is my thinking.... yields are rising towards 6% for reasons cited. Alongside Fed/ Treasury are fighting this, but market forces are trying to flatten YC. Hence pressure at short end rising. At some point rising long yields will threaten economy and that point marks peak long yields. The bearish curve flattening will turn into a bullish steepening, probably when commodity markets peak. Is that 6m, 12m, 18m? Not sure...
Michael — could this be less "policymakers resisting an inevitable adjustment" and more a deliberate choice? Running NGDP hot via inflation and a weaker dollar is a classic way to shrink debt/GDP without spending cuts or default — financial repression, 2026 style. Do you read YVC as monetization gone wrong, or as a rational policy choice made with eyes open? And given the 1951 Accord parallel — how much runway does a deliberate repression strategy actually have before the bond market forces the issue, versus the decades of tolerance we saw post-WWII?
Peter, it could be. But to stop pressure on short end repo liquidity would have to be very carefully managed. I suppose the decision to halt RMP to mid-Sept implies they will restart them again in bigger size? YVC fits with Bessent's u/s of basis trade. The correlation of MOVE with future buybacks looks just too close to be random even if the spikes are bill purchases(?!). And, may be tge bond markets are smarter today than in 1950s/60s or at least less tolerant?!
Brilliant.