The bond market isn't buying what Fed Chair Warsh is selling

jmyeet

As everyone should know by now, the US government runs a massive deficit, that is the difference between tax receipts (and other income) minus expenses. The current US public debt is hovering around $40T and the annual deficit is pushing toards $2T. A lot of that $40T was borrowed at lower interest rates but let's assume for argument's sake that it was borrowed at 5%. That's $2T in interest alone every year. There's a huge difference between adding $2T in debt at 5%+ every year vs 1-3%. The Fed has auctions to sell its debt. That market clears at a certain interest rate so if the market isn't buying the debt the rate the Fed pays has to go up. That's what's happening here. What's driving this is that inflation is above the ~2% target. Well above, actually. There are generally two ways of tackling high inflation: with monetary policy (ie raising interest rates) and with fiscal policy (by raising taxes). Modern US administrations (both parties) have completely abandoned any pretense of ever raising taxes. That was the appropriate solution during the inflation shock of 2020-2022. Some European countries did this with a corporate windfall profits tax (eg Spain). The US did not. The problem is that since housing is such a huge part of consumer spending, higher interest rates mean higher mortgage rates, which means higher housing expenditure, which means higher inflation. Now luckily most mortgages in the US are 30 year fixed so this is slow to respond and only really affects new mortgage. Other countries aren't so lucky. But the big drivers in inflation are soaring grocery costs and energy costs. Energy costs, particularly diesel, is a massive driver of inflation. The rise in groceries since Covid has completley outpaced inflation while real wages have fallen. There's only so much more inflation the American consumer can take. Household savings rates are already very low so there's very little in the way of a buffer to absorb higher costs. This is all being exacerbated by the disastrous war in Iran and the war in Ukraine. Russia had been a net exporter of diesel until recently as Ukraine has damaged an estimated 40% of Russian refining capcity. Refineries in the Gulf have also been taken offline. There's been a loss of over 1 million barrels per day in refining capacity. This is somewhat paradoxically why crudel oil prices are relatively low given all that's going on: because crudel oil is mostly useless unless it's refined. Destroy refineries and demand for oil goes down. But the demand for refined petroleum products goes up, way up [1]. It should be noted that China has essentially saved the world economy up to this point [2]. The closure of the Strait of Hormuz blocked the passage of ~20 million barrels per day of crude (plus 20-30% of the world's natural gas plus fertilizer plus helium). The inflation shock of 2020-2022 occurred because we lost "only" 10 million barrels. But China seemingly cut their imports by 5M. Saudi Arabia diverted 5-7 via the East-West pipeline to the Red Sea. The US has been draining the strategic reserve and so net we've only lost a few million barrels per day. That's temporary. the SPR has hit historic lows not seen in 40 years and it can't get much lower without risking a collapse of the salt caverns it's stroed in in Louisiana. Nobody knows if and when that'll happen because we've never done this before. The backdrop for all this is that there has been a decades-long effort at this point to essentially loot government coffers in the US. More tax cuts for the top 0.01%. The Western world in general has reached a breaking point where land hoarding and wealth need to be taxed or society as we know it will actually break down. I'm not being hyperbolic. Currently, there's no concern for that from the looters because upheaval means war, which means more weapons sales. Also, free movement of capital means the wealthy believe they can just flee. For context, a mere 10 years ago the US total public debt was ~$16T. It's 2.5x'ed in a decade and only going to get worse unless something drastically changes. Warsh was put in to cut rates for political purposes. The best he can do is to hold rates steady because they really should go up in an environment where we aren't going to raise taxes. As for Iran, it's been clear since at least April, that this is an unmistakable and undeniable total strategic defeat for the US and there is no way out other than to surrender. This event will be written about in history books as a turning point in the world order that was designed by the US, for the US after 1945. We are entering a new era. This is going to redefine US relationships all over the world. [1]: https://rbnenergy.com/market-data/3-2-1-crack-spread [2]: https://www.theatlantic.com/economy/2026/07/china-iran-usa-o...