$38 Trillion

The U.S. national debt crossed $38 trillion for the first time this week, just two months after breaching $37 trillion. The Treasury has effectively added another trillion dollars in about 60 days, underscoring how quickly borrowing needs are compounding. Roughly 80% of that debt is held by the public, meaning real investors, both domestic and foreign, finance an increasingly expensive U.S. government. With interest rates still elevated, the annual cost of servicing that debt will soon exceed defense spending. The last time the U.S. debt-to-GDP ratio grew this fast outside of wartime was in the 1980s.

• Debt service costs as a percentage of the US budget are approaching 20%
• If rates remain elevated, this number will continue to grow, crowding out other Federal government spending ability
• This further handcuffs the Federal government in being able to respond to the next economic downturn fiscally
• It will mean the Federal Reserve will have to step up to stimulate the economy
• This has inflationary implications that would exacerbate the Fed’s ability to follow its dual mandate of price stability (inflation) and full employment
• With CPI reported today at almost 3% and the Fed already expected to cut rates two more times in 2025, we believe we are already there
• The environment is supportive of real assets and inflation-sensitive exposures, and negative for long-term US treasuries

Markets show vulnerability

Markets have shown signs of strain in recent weeks, not outright panic, but small cracks that suggest liquidity is thinner than headlines imply. Two weeks ago, on the back of some China tariffs headlines from Trump, stocks sold off abruptly.  The VIX spiked and the Fear and Greed index spiked to levels usually seen during significant declines.  This week, gold and silver, which have been on a parabolic rise, sold off ~6% and ~9% respectively in one session, moves not seen in over a decade. Credit spreads also increased abruptly as risk sentiment shifted.  Cryptocurrency markets also experienced sharp declines as liquidity disappeared, with Bitcoin falling over 10% in a few days and many smaller coins declining by more than 30%.

• Stocks recovered and traded back to all-time highs to end this week
• Credit spreads also recovered somewhat
• Gold, silver, and crypto stabilized but have not quite recovered to their previous levels
• The swift spike in volatility and Fear and Greed indicators showed us how fragile these markets really might be
• This indicates liquidity in markets may not be as robust as what all-time highs would suggest
• It will be important to watch, as additional unexpected negative news can have similar or worse reactions

Japan’s political shift

Japan’s ruling Liberal Democratic Party elected Sanae Takaichi as its new leader this month, positioning her to become the country’s first female prime minister. The change follows a disappointing election season for the LDP, which lost ground in the upper house and faces public frustration over rising living costs and slow reform. Markets have reacted cautiously: the yen has weakened, bond yields have climbed, and investors are debating whether this marks a shift in Japan’s long-standing fiscal and monetary stance. For the world’s fourth-largest economy, leadership changes rarely move global markets, but this one comes at a delicate time for both policy and geopolitics.

• In addition to being the fourth largest economy in the world, Japan is the largest foreign holder of US treasuries
• A new leader intent on strengthening the economy in new ways will have certain ramifications in global markets
• With the yen trading at low levels not seen since the summer of 2024, inflationary risk is high
• If the new PM pushes policies to strengthen the yen, it would likely entail raising interest rates and potentially selling US treasuries
• Given the sizeable holdings of US treasuries, this could put upward pressure on US long-term interest rates, which would be counter to the Fed’s own efforts

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