The Art of Intimidation

James Carville once said he wanted to be reincarnated as the bond market because “you can intimidate everybody”. Treasury Secretary Scott Bessent was its latest victim. As he gave his CNBC interview, the bond market rejected his views and drove bond yields higher. The numbers are not good. The U.S. annualized fiscal deficit to GDP rose from 5.7% in June to 6.1% in July. The debt blew past the psychological barrier of $40 trillion of debt outstanding. U.S. interest payments and entitlements are 98.4% of federal government receipts up from 96.2% in June. This is not surprising. In past London Briefs I’ve spoken about how these deficits are cash accounting, but on an accrual accounting basis, which provision for future liabilities, the accrual deficits are much higher. Each month those provisions slowly metastasize into cash and relentlessly push up entitlement spending. Tariffs were reversed. This meant total receipts dropped 1.3% in July. In his interview, rather than suggesting ways to consolidate the fiscal deficit, Bessent leaned on growth will take care of it, “yields don’t reflect the underlying fundamentals”, and “we have a big toolkit”. He told the bond market he had asymmetric information on his intervention in Japan. We will see his great “bring Iran to its knees” plan on Monday. He also tried to convince hyper-scalers to not tap longer-dated debt markets, which compete with the 30-years he has to issue, and try to shoot for the 5- and 10-year maturities because they should be making nice returns on their investments to pay off the debt more quickly. Something tells me that they won’t listen. We’ve seen this story before. The Japan yield curve management exercise in 2022-23 didn’t work, nor has its recent actions to try to stop the yen from breaching 160. Or examine Andrew Bailey’s gilt intervention in October 2022, which initially brought down yields, but then quickly reversed when he told pension funds that he would stop buying gilts. Or look at the bond market’s reaction to Liz Truss’s disastrous mini-budget plan, which forced her tenure to be shorter than store-bought lettuce, something which Labour’s leaders keep front of mind in their decision-making. Let’s examine the various market dynamics that will impact bond yields in the months ahead. First, Bessent is implementing or threatening to implement a treasury twist, where he buys long-end bonds and sells the short-end. His view is inflation is temporarily high because of Iran, and once Iran comes to the table inflation will drop. His actions, however, seem to be offset by the hyper-scalers who are issuing massive amounts of debt in the corporate bond market at increasingly higher yields for long maturities. Barclays projects record $1.9tn investment-grade issuance in 2026 vs $1.4tn last year, heavily long-dated. Google issued Australian bonds close to 7%. This competes against 30-year Treasuries and there is a crowding out effect. Bonds sit at a massive underweight relative to equities. The bond market also sees a looming conflict between the Treasury and the Fed, which is why Bitcoin and gold have been precipitously rallying. There is an important fiscal reason for the Fed to not increase rates as the Treasury is increasingly reliant on short-term funding. The 30-year Treasury at 5.34%, the highest since 2007, is driven by a term premium reflecting supply/demand deterioration at the long end. This is structurally different and harder to reverse through monetary policy alone. The bond market selloff occurred despite dovish July data. However, the U.S. has drawn down oil reserves to historic lows, and the data centre construction boom is creating inflationary pockets. Voters’ number one concern is affordability, and the Fed has not brought inflation to its target. It’s likely future prints are not as benign as July, which will create tension between the Fed and Treasury going into the midterms. There is precedent from the 1950-51 Fed-Treasury confrontation of how this could look. After World War II, the Treasury wanted to keep yields capped at 2.5%. Inflation had been accelerating as America started to fund the costs of the Korean War. This led to the Treasury- Fed accord which established the principle that monetary policy shouldn’t be subordinated to keeping government financing costs low. The actions in the gold and Bitcoin market suggest concern that this accord may be ending. The sequence that is concerning is that sustained 30-year yields above 5.25-5.5% impair AI capex project economics. Corporate issuance slows or spreads widen. The equity bid that's been masking Treasury stress loses its fundamental support. Foreign private capital inflows reverse and the dollar weakens. Japanese and other Asian investors face renewed FX hedging cost pressure on their Treasury holdings. And Bessent's yen intervention engineering gets overwhelmed by the scale of the flow reversal. All of this is now more plausible than it was 30 days ago. There is a clear solution to arrest this path: raise taxes and/or shrink spending. It’s worth noting that while the U.S. government leveraged up, overall debt has remained stable for over 15 years. Households and corporations (outside the hyper-scalers) have reduced their debt burden relative to GDP, fuelled by economic growth, fiscal stimulus, tax cuts, and a variety of other factors. My best guess is that buybacks, jawboning and twists can dampen volatility in any given week, but none of it touches the deficit maths driving the term premium. I think there is a 60/40 chance that the 30-year hits 5.5% before it revisits 5.0%. The catalyst would be a soft auction or a hot CPI print. This then forces the administration into the fiscal consolidation the bond market wants, which would be negative for equities. Hang on to your seats. Japan’s Broken ‘Wa’ 和 in Japanese means ‘wa’ or the ideal of harmony, especially between competing forces. Japan reported soft data with real GDP only rising 1.1% on an annualized basis for 2Q 2026 compared with consensus expectations of 2.0%. But the GDP deflator rose 0.9% in Q2 versus 0.1% in Q1. This means inflationary pressures are pushing up nominal GDP growth and increasing the pressure for the BOJ to raise rates. But a rate increase will add to Japan’s fiscal burden. Japan’s gross interest payments are currently 1.5% of GDP versus the U.S. at 4.5% of GDP. This imbalance increases pressure on Japan institutions to sell U.S. Treasuries and buy yen.
The U.S. net international investment position (NIIP) was at a deficit of $7.8 trillion or 39.9% of GDP in 2017 and has gone more negative to 68.1% of GDP at end of 1Q 2026 or $21.3 trillion. This shows an extreme dependence on foreign capital. Japan’s NIIP surplus has gone from 58.3% of GDP in 2017 to 84.3% at the end of 2025 and was at 83.3% at the end of 1Q 2026.
The data shows that the natural flow for ‘wa’ would be for Japan to shrink its NIIP surplus and the U.S. to shrink its NIIP deficit. A reduction in Japan’s NIIP surplus would essentially involve selling Treasuries as Prime Minister Takaichi’s growth plans, at least so far, haven’t been successful. Predicting a major near-term change to Japan's Treasury holdings is as fraught as shorting JGBs, a trade that has cost many their jobs, so I won't try to time it. But the direction of the pressure isn't in question. Every quarter the deflator stays hot, and the NIIP gap stays this wide, Japanese institutions have one more reason to be net sellers of Treasuries and buyers of yen. The imbalance doesn't resolve itself; something eventually must give. No More Denial In Private Credit Golub Capital's co-CEO was quoted in the Financial Times saying, "We're in a credit cycle... Others denied it for a while. I don't think there's a lot of denial anymore." This is the same Golub Capital co-CEO quoted in a WSJ piece two weeks ago, where he was careful to say the credit cycle was "not a particularly bad one." The emphasis has shifted to "no more denial", a subtle but real escalation in tone from the same source. There are several datapoints, metastasizing over the past few months, that provide evidence for the shift in tone: Thoma Bravo wrote down its $5.1 billion equity stake in Medallia to zero rather than inject fresh capital, and Blackstone's credit fund marked its Medallia loan at under 50 cents on the dollar at end of June, down from 60 cents in March, on a loan that was presumably closer to par not long ago. This is a large-cap, sponsor-abandoned software credit. Ares wrote down its loan on Cornerstone OnDemand. Here is a second named software/HR-tech credit taking a markdown from a top-tier direct lender. Non-accrual rates at the 20 largest public BDCs hit a median 2.8% of cost in Q2, up from 2.0% in Q1, a jump of 80bps in a single quarter. The FT's analysis states these levels haven't been seen since 2017, the last time the industry was working through post-oil-crash stress. Fitch separately confirmed private credit defaults hit a new record in July. FS KKR Capital Corp says 7.1% of its loan book is troubled "far above the industry average" even after a slight sequential improvement. Repayments/sales are outpacing new originations at the largest BDCs, KKR, Blue Owl, and Apollo's MidCap Financial. The entire model of continuous capital recycling that private credit relies on is stalling. Less new lending plus more troubled legacy loans is a double squeeze on returns. BlackRock's TCPC sold a $523 million loan block and has hired bankers to explore wind-down options, evidence of a major manager actively contemplating shutting down a distressed vehicle rather than working through it. This is a distinct escalation from gating (Partners Group, Apollo, Blue Owl). TCPC is discussing liquidation, not just redemption limits. Oppenheimer's Mitchel Penn notes the bottom-quartile BDCs have generated 5-year average ROEs below the 10-year Treasury yield. It means a meaningful slice of the industry has been compensating investors worse than a risk-free asset for taking on illiquid, leveraged, and non-investment-grade credit risk. He said some funds are "priced for death" and that "underwriting wasn't as good as it should have been... they weren't as picky". The FT noted the losses are concentrated mostly in the 2020-2021 vintage, the zero-rate era, peak-multiple private equity buying binge. Executives across multiple earnings calls are pointing to this specific cohort as the source of trouble. In the darkness, there is opportunity. The 2025-2026 originations have the potential to be more attractive. But we are not at a bottom. Oaktree is conserving capital to "lean into" future volatility. The credible distressed-buyer cohort (Oaktree, Diameter, Sona, Coller) are keeping dry powder for a defensive-now, opportunistic-later posture. That's a strong signal that further deterioration is coming. End Note I’ve mentioned in past briefs that China has been trying to create a parallel monetary system. I don’t have much data to estimate how it’s going. But this video from state-run China Xinhua News shows they are at least starting their marketing campaign. https://x.com/xhnews/status/2090260731560423766?s=43&t=GcE7CDK3Ezb8q5t0rO89zQ Trump noted in his Truth Social announcement that he "recently asked the President of South Korea if they would like to join us in the Denuclearization of the Islamic Republic of Iran, and they said, 'No thanks!'” Trump subsequently said he would substantially reduce an annual military exercise so as not to provoke North Korea, with whom he has a good relationship. North Korea signalled its appreciation by launching several ballistic missiles four days later. Omar Sayed