The pressure on the US Treasury market has persisted over the past week, with the national debt climbing to a record $40 trillion. Deepening worries over the fiscal deficit outlook and long-term inflation risks pushed the 30-year Treasury yield to 5.334% on August 18, its highest level since 2007. Following the Treasury Department's announcement on August 19 of a "sell short, buy long" repurchase operation, that yield eased to 5.183%, but has since rebounded to 5.276%.
Treasury Secretary Bessent recently stated that the US has a "good chance" of moving onto a path of narrowing fiscal deficits, claiming that "yields do not reflect underlying fundamentals" and specifically noting that the 30-year Treasury market is "very illiquid." He also reiterated that each Treasury repurchase operation could exceed $4 billion.
However, Arthur Budaghyan, head of the core macro platform at global investment research firm BCA Research, told reporters during a seminar that Bessent's expectations may not materialize, and a full-blown stock-bond collision could be unavoidable. If the term premium gets completely out of control, with the current Fed chair strongly rejecting quantitative easing (QE), conventional operations alone cannot resolve the issue, potentially forcing the Treasury to resort to financial repression measures.
Budaghyan believes that "Bessenomics" may appear to lower core real interest rates, but it cannot control the term premium or inflation expectations. This means that as long as market concerns over US fiscal and inflation risks persist, long-term Treasury yields could be pushed to levels high enough to puncture the stock market bubble. In his view, a "stock-bond collision" is imminent.
Specifically, Budaghyan explained that the strategic core of "Bessenomics" lies in using various means to lower interest rates to stimulate economic growth and stabilize the public debt ratio. The nominal Treasury yield can be broken down into the core real yield, the bond term premium, and the inflation compensation rate. Even if the Treasury and the government can artificially suppress the core real yield, they simply cannot control inflation expectations or the term premium.
"The recent rise in Treasury yields alongside a weakening dollar is precisely because the increase in TIPS yields is entirely driven by the term premium, while core real yields have peaked and are falling, and the dollar has responded sensitively to the decline in core real yields," Budaghyan said. "The more aggressively the government pursues stimulus or market-distorting interventions, the higher the term premium and inflation premium the market will demand."
Budaghyan is also not optimistic about a "soft landing." He suggested that if the 10-year Treasury yield remains elevated due to the term premium and inflation expectations, breaking above 4.5% and staying high in the short term, "Bessenomics" will fail to prevent a full-blown collision between the stock and bond markets.
"The past 45 years of history show that sustainable peaks in Treasury yields and the start of bull markets have, without exception, been accompanied by major crises in financial markets or the real economy," he said. Historically, cyclical bond bull markets are often accompanied by sharp corrections or crashes in stocks. This is because periodic peaks in bond yields often require a significant decline in market risk appetite and a massive shift of funds from risk assets to safe havens, particularly Treasuries.
For example, the "Black Monday" of 1987, the dot-com bubble burst in 2000, the subprime mortgage crisis in 2008, and the liquidity crisis triggered by COVID-19 in 2020 are all repetitions of this pattern. Currently, the structural fragility of the US stock market provides ample conditions for such a shock.
Budaghyan noted that US corporate bond spreads are currently in an extremely narrow and fragile state. After inflation adjustment, US stock valuations are in an extremely overbought zone at two standard deviations above the historical trend line. Analysts' long-term earnings per share (EPS) growth expectations exceed 20%, which is even higher than the peak of the 2000 tech bubble.
Budaghyan told reporters that in the face of massive and unsustainable public debt, in a crisis or quasi-crisis scenario, the US government is highly likely to use administrative and regulatory measures, such as requiring large commercial banks like JPMorgan Chase to purchase Treasury bonds on a large scale to suppress yields, implementing a "commercial bank version of QE" and financial repression measures. However, he also pointed out that this approach comes with costs.
In an open economic system with free capital flows, the price the government pays for forcibly suppressing bond yields is inevitably the abandonment of exchange rate stability. According to the "impossible trinity" principle, when a country maintains both free capital flows and an independent monetary policy, the exchange rate must be entirely determined by the market. When the government forcibly intervenes in interest rates through administrative means, huge fiscal deficits combined with slowing foreign capital inflows will lead to a sharp one-way depreciation of the dollar.
Budaghyan stated that although US fundamentals are relatively strong, its growth is built on overstretched operations, massive fiscal deficits, and unsustainable public debt. From a long-cycle perspective, financial markets have a cyclical reversion pattern. Even if the logic of AI and productivity improvements is acknowledged over the long term, US stocks and tech stocks will experience an extremely painful digestion of high valuations and a deep correction over the next 6 to 12 months.
In this context, Budaghyan proposed a macro analysis framework called "Get Out of the Dollar." He assessed that the US's current account deficit, fiscal deficit, and reliance on foreign capital have all exceeded the levels seen before the Nixon shock of 1971. At that time, unsustainable balance of payments imbalances ultimately forced the dollar to decouple from gold and depreciate significantly.
Specifically, the current fiscal and debt burden is heavier than in 1971. According to data from the St. Louis Fed, when the dollar was forced to devalue in 1971, US government debt as a percentage of GDP was only 35% and on a downward trajectory. Today, the US debt ratio has reached 120% and continues to climb. According to the Congressional Budget Office, the primary budget deficit as a share of GDP was near zero in 1971, whereas it has now reached 5.8%.
On the other hand, external imbalances and capital dependence have intensified. Data from the Bureau of Economic Analysis (BEA) shows that in 1971, the US current account was roughly balanced with net FDI inflows. Today, the US current account deficit is close to $1.18 trillion, while net FDI is essentially zero, making the country extremely dependent on foreign portfolio investment to finance its deficit. According to the Treasury Department's "Treasury International Capital" report, foreign investors' net purchases of long-term securities over the past 12 months totaled $1.33 trillion, with stocks accounting for $909 billion.
Budaghyan noted that this model of extreme reliance on external capital inflows to fill the deficit gives the US balance of payments a distinct "crocodile mouth" shape. The "upper jaw" is the over $1 trillion in net portfolio investment inflows over the past year, while the "lower jaw" is the equally massive current account deficit of nearly $1 trillion.
"According to the balance of payments identity, once global enthusiasm for dollar assets cools, the line representing capital inflows above will begin to decline. It is expected that portfolio investment inflows could halve from $1 trillion to $500 billion over the next 12 months, and the current account deficit below must correspondingly narrow to achieve rebalancing," he said. Given that it is difficult to fill the gap through an explosive growth in exports, the only path to rebalancing is a significant depreciation of the dollar, forcing a sharp contraction in US import demand.
Based on this structural imbalance, Budaghyan projects that the dollar could enter a period of significant depreciation over the next 12 months. The operational logic of the foreign exchange market may also reverse, with the dollar shifting from a counter-cyclical safe-haven currency to a pro-cyclical currency, while the euro may re-emerge as the counter-cyclical currency.