In recent weeks, the United States has faced a deepening crisis linked to its bond market, a situation that has thrown the political landscape into disarrayThe removal of Speaker of the House Kevin McCarthy—marking a historic step as he is the first Speaker to be ousted—underscores the severity of the country's fiscal challengesThis upheaval is compounded by the alarming financial landscape, as the Federal Reserve reported staggering losses reminiscent of times during major economic downturnsAll these developments are intertwined with the spiraling situation of U.STreasury bonds, which have started to exhibit characteristics of a major bear market.

The U.Sis currently experiencing “the biggest bond bear market in history.”

U.S

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Treasury bonds have long been regarded as a safe haven asset, forming the foundation of global asset pricingHowever, recent market dynamics have pushed the yield on the benchmark 10-year Treasury note to heights unseen in 16 years, soaring to 4.89%. This marks a significant decline in bond prices—specifically, a staggering 46% drop from the peak levels recorded in March 2020, drawing comparisons to the aftermath of the 2000 dot-com bubble when the U.Sstock market fell by 49%.

The decline in 30-year bonds was even more pronounced, plummeting by 53%, closely mirroring the severe 57% drop of U.Sequities during the 2008 financial crisis.

As the third-ranking official in the U.S

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government, McCarthy became the first casualty of this financial storm, but analysts believe he may not be the last.

On October 3, members of the House voted 216 to 210 in favor of the motion to remove McCarthy from his positionThis decision came only three months after the government narrowly avoided a shutdown.

The immediate cause of McCarthy's ousting was once again tied to the impending threat of a government shutdown—a recurring theme in recent monthsJust hours before the government was set to halt operations on September 30, McCarthy, representing the Republican leadership, decided to compromise with the Democrats and passed a temporary funding bill to keep the federal government running

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However, this bill did not include demands from the hardliners within his party for significant cuts to federal spending or stricter border controls, which swiftly led to a motion for his dismissal led by Congressman Matt Gaetz on October 2.

The stopgap bill McCarthy helped pass only extends funding for 45 days, effectively securing government operations until November 17. Without further legislative action to secure additional funding, parts of the government face closure as early as November 18.

While McCarthy’s removal reflects partisan tensions in Washington, it is undeniably rooted in the broader issues surrounding U.STreasury bonds.

Currently, the U.S

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government finds itself in a predicament: operating without borrowing is no longer viable, especially as Treasury debt eclipsed $33 trillion for the first time in September, marking another unprecedented milestoneThis staggering figure appeared just three months after the national debt had barely crossed the $32 trillion mark.

This means that in the span of three months alone, the Treasury issued another trillion dollars in debt—an alarming rate of increase.

Compounding these issues is the Federal Reserve’s rapid interest rate hikes and balance sheet reductionsWith the Fed, a longtime major buyer of U.Sdebt, pulling back, the onus of absorbing new debt issuance now falls squarely on the market, creating liquidity concerns in the Treasury market and propelling bond yields upwards

Consequently, the government faces increased borrowing costs as it seeks to issue new debt at higher interest rates.

Maya MacGuineas, president of the Committee for a Responsible Federal Budget, remarked, “The United States has reached a milestone that no one can take pride in—our national debt has just crossed $33 trillionWe are becoming desensitized to these enormous numbers, but that does not diminish their peril.”

U.STreasury bonds are widely regarded as the gold standard of “risk-free assets,” and analysts on Wall Street utilize bond prices as the "anchor" for determining the value of other securitiesIn recent days, the significant drop in Treasury bond prices has sent ripples throughout the global markets.

On October 6, the U.S

Bureau of Labor Statistics released job market data showing that 336,000 jobs were added in September, far exceeding the anticipated figure of 170,000. The upward revision of combined job growth for July and August by 119,000 jobs, now totaling 236,000 and 227,000 respectively, reflected a robust labor market.

These strong employment numbers have heightened expectations for further interest rate hikes by the Federal Reserve, leading to a sharp decline in bond prices and rise in yieldsAt one point, the yield on the 30-year bond surpassed 5%, while the 10-year note approached 4.9%, reaching its highest level since 2007. Compared to the yields of 3.40% and 3.52% earlier this year, this marks an increase of over 40%.

Alongside rising rates, the largest long-bond fund in the U.S., the iShares iBoxx $ Treasury 20+ Year Bond ETF (TLT) with a market cap of $39 billion, has seen its value fall by nearly 48% from its historic peak in 2020, effectively halving in value

Year-to-date, the ETF has declined about 10%, while it plunged 33% last year.

The surging yields on bonds have also contributed to a stronger dollarSince mid-July, the average value of the dollar against G10 currencies has risen approximately 7%. The dollar index, which measures the dollar's strength against six major currencies, is nearing a 10-month high.

The spillover effects of rising Treasury yields are inevitably spreading to bond markets around the globe.

On October 4, the yield on UK 30-year bonds reached 5.1%, the highest level since September 1998.

The yield on German 10-year government bonds has climbed to 3%, returning to levels last seen during the Eurozone debt crisis in 2011.

In Japan, traditionally known for maintaining ultra-low interest rates, the yield on 10-year bonds has surprisingly exceeded 1%.

Australia has also faced “double trouble,” with its 10-year bond yield dropping at a pace that sometimes outstrips that of U.S

Treasury bonds.

For the United States, the repercussions of soaring Treasury yields are being felt across multiple sectors, including stock markets, banking, and real estate.

Since September, all three major stock indexes in the U.Shave experienced considerable declinesThe Dow Jones has dropped by 3.79%, the S&P 500 by 4.42%, and the Nasdaq by 4.3%. On October 5, Apple CEO Tim Cook sold approximately $41 million worth of stock, marking his largest single-sell-off in over two years, a sign of his caution regarding Apple’s market outlook.

Companies in a high-rate environment face increasing borrowing costs, forcing them to issue debt only in high-yield markets

The Federal Reserve's economic data indicates that the ratio of corporate debt to GDP has surged to record levels following the relaxed lending conditions at the COVID-19 pandemic's onsetThis presents the reality that firms will need to navigate a higher yield environment during refinancing, compelling them to curtail expenditures and investments.

As bond yields and mortgage rates rise, the real estate sector feels the pressure even more acutelyThe 30-year fixed mortgage rate, the most popular housing loan rate in the U.S., has surged to its highest point since 2000.

Peter Boockvar, chief investment officer of Bleakley Financial Group, noted, “For anyone with debt maturing, this is a rate shock

For real estate professionals with loans coming due or for any businesses facing floating-rate debt maturity, it is challenging.”

The surge in rates has also put pressure on regional banks holding bonds that have lost value—this crisis was pivotal in the collapses of Silicon Valley Bank and First Republic BankWhile analysts predict no further bank failures in the near term, the banking sector has been seeking to offload assets and has already scaled back lending.

Currently, financial conditions are tighter than beforeBanks have the Federal Reserve's Bank Term Funding Program as a backstop, providing temporary security from risk, but this support will expire in six months. The negative impacts of high rates on financial markets may ripple further into the future.

Lindsay Rosner, managing director of Goldman Sachs' cross-asset investing, remarked, “Our yields are currently 100 basis points higher than they were in March

If banks haven't resolved their issues since then, the problems will only grow, as rates continue to climb.”

Since the Federal Reserve began raising rates last year, the financial landscape has seen two major tremors: the “UK Gilts Crisis” of September 2022 and the regional bank crisis in the U.Sin March 2023.

Bob Michele, CIO at JPMorgan, warned that an uptick in 10-year Treasury yields could increase the likelihood of other economic factors failing and heighten recession risks.

“If long-term rates exceed 5%, that is undeniably another rate shock

At that point, one must keep a keen eye on any aspects that appear vulnerable,” Michele commented.

Ultimately, the surge in Treasury yields is rooted in an imbalance between supply and demand.

From the supply side, the U.Sgovernment is likely to continue running high deficits in the foreseeable future, which means a continued wave of debt issuance is anticipated. The Treasury plans to net issue $1.01 trillion and $852 billion in bonds over the third and fourth quarters, respectivelyConcurrently, the Federal Reserve is ongoingly reducing its bond holdings through quantitative tightening, a strategy that has cumulatively decreased its Treasury holdings by $1.3 trillion since 2022, further inflating the supply of U.S

debt.

On the demand side, however, foreign investors appear to be reducing their holdings overall, with total bonds held declining by $121 billion since 2022.

As the Bank of Japan gradually adjusts its yield curve control policy, the possibility of normalizing monetary policy increasesIf the BOJ reshapes its monetary strategy, demand for U.Sdebt may diminish significantly.

Additionally, emerging economies are feeling the strain of a strong dollar, exacerbating the depreciation of local currencies, further complicating matters as these countries will likely offload U.S

bonds to stabilize their currency exchange rates.

A continuous decline in overseas demand could shift the burden of excess supply onto the domestic front in the U.S.

Yet the reality stands that U.Sdomestic capabilities to absorb substantial bond purchases are limitedThe liquidity crisis that rocked the banking sector in March diminished its capacity to take on Treasuries, especially those with long duration.

Treasury yields are surpassing previous records, yet long-term buyers are struggling to keep paceHow high can yields rise before the imbalance becomes untenable?

Nick Timiraos, often referred to as the “new Fed whisperer,” warns that the escalating long-term Treasury yields are eroding hopes for a soft economic landing, as skyrocketing borrowing costs could substantially decelerate economic growth and bolster the chances of a financial market collapse, thereby potentially attenuating the rationale for further Fed rate hikes this year.

In fact, the Federal Reserve itself is facing substantial losses unseen in a century.

Influenced by prior balance sheet expansion and prevailing interest rate hikes, the Federal Reserve has incurred an operational net loss amounting to $57.38 billion during the first half of 2023, with annual losses projected to exceed $100 billion

The last time the Fed reported an annual operating net loss was in 1915.

This Fed shortfall means that U.Sfederal revenues will be directly impacted, with the Treasury not set to receive net profits from the Fed until after 2026.

Although the Fed maintains that operational losses and unrealized losses will not influence its monetary policy, they may pose significant challenges for addressing inflation.

Former Treasury Secretary Lawrence Summers pointed out that recent job data suggests that the Fed’s rate hikes are no longer yielding the same effects as before, raising the risk of a hard economic landing.

As job growth accelerates, the risk of a hard landing appears to be “more pronounced.” Interest rates may cease to act as an effective economic steering tool, meaning that when economic cooling is needed, those rates could fluctuate more than ever.

Summers further cautioned that, given the current bond market sell-off and the rising valuations in various sectors, including private equity, the U.S

economy may be sitting upon a precarious pile of dry kindling.

Albert Edwards, a prominent strategist often termed the “big short,” vocally warned, “The resilience displayed by U.Sstocks in the face of rising bond yields reminds me of the events of 1987; the stock market eventually crashed under the weight of the bond market.” Barclays analysts have gone so far as to declare that only a stock market crash could save the bond market.

Both Goldman Sachs and JP Morgan analysts have concurrently issued warnings that should interest rates keep climbing, a financial crisis might ensue.

But the stark reality remains: a debt crisis—originating from the U.S