Europe’s Debt Problem Is Back

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0:05 Radio. News.

0:08 The 10-year has just broken through another level.

0:11 Bloomberg Opinion's John Authors came into the studio Monday morning just as the 10-year bond yield hit 5.3%.

0:19 So it's now at a 24-year high. So it's gone higher than it ever did in the spike that precipitated the financial crisis.

0:29 Wow. Are we at a crisis moment when it comes to bond yields?

0:32 In the U.S., no. In the case of France, you have very imminent signs of a potential crisis in Japan and also in the U.K.

0:46 I'm Sarah Holder, and this is The Big Take from Bloomberg News. Today on the show, I sit down with John and Heather Long, the chief economist at the Navy Federal Credit Union, to talk about where bond yields are rising. how central banks around the world could respond, and how consumers in the U.S. are feeling the pressure. So we've been talking a lot on the show about the sharp rise in bond yields in the U.S. In the past week, yields on 30-year bonds have hit 5.66%. There's that new record for the 10-year. It's at its highest yield since 2002. Heather, what does this all tell you about where we're at in the U.S. right now?

1:33 To me, the most interesting question right now is this debate around are these yields rising, in the U.S. at least, due to a stronger economy? You know, we have gotten a lot of interesting data in the last month that points to a healthier consumer than maybe many expected, a healthier job market than maybe many expected. So I think that debate we have had some fresh data on and is one of the most interesting right now. That's a more positive story. And obviously the White House has fully embraced that story. But you hear a lot of smart voices making that case versus, you know, I lean more on the side.

2:15 What this is really telling.

2:16 Us is a belief in the market that taming inflation is going to be a much harder task.

2:22 It's going to take longer than we thought.

2:24 And that's both in the short-term context of what Fed Chair Kevin Warsh can do and in the longer-term context of the demographics and the fiscal situation of the U.S.

2:36 And many other countries.

2:37 So I lean more on that more negative spin, but I think it's a really interesting debate.

2:43 And when it comes to these global markets, again, we're seeing France, U.K., Japan– seeing high yields as well. How much of that is caused by the US or set off by what's going on in the US bond market? And how much of it is related to sort of domestic factors in these countries?

2:59 Both, naturally. The way to look at this is like a spark to light a flame. So you don't create a crisis from nothing if a country has its house completely in order. But similarly, if the markets are complacent and allow you to carry on, you can have the conditions for a crisis for quite a long time without being called on it. Japan has been an exception to every rule for a very long time. But if you have rates at 10-year yields with zero for many years, because the Bank of Japan literally wouldn't let them rise beyond that, they're now at 3%. That's very serious. I think in Japan, there is the possibility you could just try to close their deficit by selling a lot of public assets. Again, much like Margaret Thatcher did back home

3:48 in Britain, there might be some relatively easy way out of that problem. But if you look at what is happening to the yields on French bonds, compared to particularly neighbouring German bonds, bearing in mind these two countries have the same currency, the same central bank, and they're supposed to be in a kind of a union that will merge their economies ever more. the market is plainly saying that it now sees French bonds as being far riskier.

4:18 Right.

4:18 The gap between French bonds and German bonds is the widest it's been since the sovereign debt crisis back in 2011.

4:24 Very nearly close to there. Very nearly close to taking that out.

4:29 Why is that so significant?

4:31 If you have that wider gap between two countries who are in the Eurozone, that means you don't really believe that the Eurozone can hold it together. You're saying as an investor placing your money that way that you think there is a real risk that the Eurozone itself will fall apart. If you have that big a gap between the borrowing costs in the two big European economies, you then get into a spiral effect. France at the moment wants to borrow more than ever before next year, which is an election year, which they start with a deficit of 5%. The cost of that borrowing is increasing significantly.

5:08 all the time because of this run. And that looks very much as though it could spark the final crisis.

5:17 Yeah, I mean, to me, this is where the politics is starting to change. The political outlook is starting to change and the market is reacting to this in certain countries around the world. John's just been talking about France. I think you can make the same argument in the United States. You know, what's changed even in the last few weeks? Obviously, we're still in a never-ending war in Iran, and we're going to run a worse fiscal deficit this year than we even expected, despite this strong economy we supposedly have.

5:43 Preliminary estimates put it at $ 2 trillion for 2026.

5:45 That's right.

5:47 And back in 2019, a more comparable economic year, we were running a $ 1 trillion deficit. So you can see just how egregious it looks. And on top of that, populism is sweeping. It's starting to sweep the United States, already some early signs of it, but seeing... The Michigan Senate candidate, Abdul El-Said, you know, surged to victory there, among other types of elections of populist candidates, is a wake-up call to the bond market that there is just no fiscal restraint.

6:17 This is totally off the table.

6:19 And any signs, you know, for a while it was, we're going to use the tariff revenue in the United States to help pay down the debt. And even though that was peanuts, at least somebody was talking about paying down the deficit. Now we have a President Trump who's out saying, I'm going to send everybody a $ 5, 000 check if Republicans win. And oh, how about a $ 90 check for people on Medicare? And so that's where I think I differ a little bit from John. I do think the politics has started to clash with that ongoing reality of the fiscal situation.

6:51 And Heather, you're tracking a lot of economic indicators here in the U.S., jobs, inflation, consumer confidence. We've gotten a lot of data drops in the past week or so that have given us a fuller picture. When you look at this data in aggregate, how high do you think U.S. bond yields might climb?

7:09 Yeah, that's the trillion dollar question right there. It's hard to predict. I'll tell you what, the way I look at it, I get worried if we get past 5.5. It's not that we've never seen it before. It's not, you know, that it can't, it could totally crash at 5.55.

7:28 On the 10-year.

7:28 On the 10-year, yeah.

7:29 I'm specifically speaking on the 10-year. But as John was saying earlier, this is a rapid repricing. There is a lot of both corporate debt that needs to be renegotiated and redone in the coming years. And to do it at such a higher rate than expected is going to trigger some bankruptcies and trigger some disruption. At the same time, obviously, at Navy Federal Credit Union, we are monitoring every day the consumer side.

7:57 Mortgage rate, it's above seven, let alone 7.5% in the 30-year mortgage. It's like being in Antarctica.

8:04 It's totally frozen. The phone stops ringing. You can see the national data going down. And I worry, too, that a lot of people, personal loans have been going up this year. And that has been the lifesaver for a lot of the bottom third of America. And that is no longer very accessible to people at these types of rates.

8:25 So there's just so much strain on the economy. Same thing in the banking sector.

8:29 You know, there's a reason the banking sector had a pretty bad September in the stock market. It's because banks are sitting on a ton. of government debt that yields well below, not just 5.5, but well below 5%. And obviously right now they're hedging and they're not selling, but it puts pressure. It puts pressure on a lot of the Main Street bank balance sheets in a world where we're at 5.5 on the 10-year or above. So that's what I worry about, this Wall Street argument that we're just returning to normal. This is just what it was like in the 90s. I think ignores the reality that a lot of people were not prepared for it to move this fast.

9:16 So how long will bond yields stay high? Is this the new normal? That's coming up. John, you have written about the idea that it's reasonable to expect yields to rise for a while after several decades of Treasury yields falling. And as you mentioned, Heather, there are some other analysts that say, you know, the bond market is returning to normal after decades of unusually low rates. To say little of the, you know, real strain this is putting on everyday people. How are you thinking about whether this is sort of like a recalibration and how long could... these yields continue to stay elevated, given your analysis?

10:04 Oh, I wouldn't expect yields to be very significantly lower than they are now. I'm I expect to be doing this job for about another 10 years. I don't expect to be seeing yields significantly lower than 5% for the rest of my career. I imagine that we are into a new normal.

10:22 Even if it's a recession, John? That's my one ask.

10:24 Well, even if it's a recession. I'm being positive for a change, yes. Yes. And that's one of the things you have, that there are natural counterweights in the way the market moves. But again, I agree with what Heather just said. I don't think it's Pollyanna-ish or anything like that to say that, broadly speaking, it's reasonable that yields should be higher and should now be trending higher for a long time, having trended lower for a very long time.

10:53 The point is how quickly people have to adjust. It's when you have sudden changes, sudden displacements that change. dangerous moments occur. Now, we particularly have, with hindsight, we can see that there was a mistake to leave rates absolutely on the floor throughout 2021, the year after the pandemic.

11:13 That was the year that all the arguments about whether inflation was transitory were going on. A lot of people very sensibly locked in extremely low rates then while they had the chance. So as Heather was saying, there's a risk that we get quite a startling array of resets. And there's What is the Warren Buffett phrase? The sea will go out and we'll see who's swimming naked. That's the risk. You cannot see it in the data yet.

11:40 I find the credit spreads, the extra yield you have to pay on a corporate bond compared to a treasury, remarkably stable. It's one of the things I don't quite understand about what's going on at the moment is that the credit market is as calm so far as it is.

11:56 Well, you know, John, you've written about how, you know, the U.S. Fed has a lot to answer for here in terms of the role it's played in stoking these fears that are rippling across global markets. Heather, when you think about how Fed Chair Warsh is trying to navigate this moment, what has worked so far and what more can the Fed do right now?

12:17 That's a good question. Well, he's gotten better, I'll give him that, as he's gone along. You know, Jackson Hole was a good step in the right direction. He gave a little bit more away in September. So I do think he is listening to the market and trying to give it a little bit more. But the most convincing person I've heard is former Fed Vice Chair Donald Cohen has done a really good job of articulating how Kevin Warsh aspires to be like Alan Greenspan, but has a long way to go to get that fine tune. How do you give just enough, I'll call it forward guidance light.

12:56 And that's where I think we need to get. And he's just not quite there yet. So I'm hopeful that he'll refine and we'll get another test here pretty soon.

13:06 Will he learn to love forward guidance?

13:09 Forward guidance, right.

13:11 He doesn't need to go the full shebang. He doesn't need to be Powell or Yellen. But he's got to give a little bit more of his view of the world so there's a better understanding. And it can't just be AI is going to do such a wonderful job and we don't.

13:27 Have to worry.

13:28 What about the European Central Bank? I mean, again, we've talked about how France is potentially nearing a crisis moment. How could the ECB get this under control?

13:39 The likelihood you've also got a very interesting political situation that Christine Lagarde's who is very widely respected, president of the ECB, is, of course, French. There's a possibility she's going to be standing down a little before the end of her term, which I think is the year after next. It might make life easier if there was a non-French person in charge of the ECB, if France is going to need help.

14:03 Because of how it would look to step in?

14:06 Yes. I would think, given the way the last crisis was dealt with, that probably gives us a template for what will happen here, which is that there'll be brinkmanship, it will be ugly, and the ECB will do as Mario Draghi put it, whatever it takes to make sure that push doesn't come to shove, that we don't actually have a fracturing of the Eurozone, that we don't have a French default. And the likelihood is that this is born of the flaws in the design of the eurozone that common monetary policy but not common fiscal policy it'll be dealt with the same way the last one was that which will avoid crisis and in the process we'll have an extremely slow and sluggish economy that carries on for longer than it should because you put up with

14:57 the bad and for kicking the can as being at least preferable to outright crisis which is what happened last time and i imagine that's the that's the most likely scenario for what will happen this time Right.

15:08 Last time around, the 2011 sovereign debt crisis that started in Greece. What is similar and what is different about this moment and how should that inform how economic policymakers design solutions or repairs?

15:22 The big difference is that France is more than 10 times the size of Greece. It was conceivable that Greece might actually leave the Eurozone. There was the moment when Tsipras and Varoufakis came in and you really did get to a crisis point. But that was 2015 and the big European banks had managed to reduce their exposure to Greece by that point. That is the single biggest problem is that Europe is based around this great Franco-German axis.

15:52 If one of France or Germany is in trouble, that is a real problem. The second issue, you could certainly argue that Angela Merkel, who was in charge of Germany at the time, was too strict and prudent to fault in the way that she dealt with that crisis that many Germans at the time felt that they were having to bail out the rest of the Eurozone for having been irresponsible. This time around, with the Alternative für Deutschland looking as though it might genuinely actually take power, it's now possible. conceivable and plainly with much more of a move within the population in favor of nationalism and against bailing out, if they felt bad about bailing out the Greeks, the idea of, I imagine bailing out the French next

16:41 door with all the historic rivalries there is going to be tougher.

16:47 Back to politics.

16:50 Ultimately, it's caused by politics, by the compromises that were made trying to to build the European project and the crisis, how bad the crisis gets will be driven by politics. If the German electorate chooses politicians who really are prepared to force a crisis and blow up the whole thing rather than Germany continuing to be the linchpin for weaker countries around them, if that's how they perceive it, then there is a risk of a much worse crisis than we had 15 years ago.

17:21 Heather, when you think about higher yields for years to come, if this is sort of a new normal, even elevated over 5%, as John predicted, what does that mean for the U.S. consumer moving forward if they have to reorient to a world where yields are so high?

17:39 To me, the most interesting question right now is how long does the U.S.

17:43 Consumer hang in there?

17:45 And I think on the consumer side, everyone agrees that the top 20% of Americans are doing fine. They don't care at all what the gas price is or the diesel price. And the bottom 25% is struggling. That's where your subprime issues are that you see. But what about that big, big middle? And I think that's where it gets interesting. There's no doubt that a lot of people are sitting on a lot of home equity who took advantage of those low mortgage rates in 2020 and 2021.

18:14 And we are still seeing a strong HELOC usage. But here's what we see in our credit and debit card data. People are still spending... But under the hood, they are rapidly moving their money around where they're spending. They are trying to cut back everywhere they can at the grocery store, and they're spending less on health care in order to still have a little bit of money to do some fun things, like go to a sporting event or buy those romantic books that are so popular or whatnot.

18:50 And that's what I worry about.

18:51 How long can this keep going with gas prices staying high, with the pressure coming from the borrowing costs right now? With the consumer sentiment really changing, yeah, it's been gloomy for a while. But what's changed is like the conference board indicator. What's changed, people have been gloomy about the future for a long time. But in that conference board survey, what really changed is when they were asked about the current economy. That really dropped a lot. So that's eye-opening.

19:22 That's the stuff that starts to make you think, ooh, is this going to be a great holiday season? I think there's going to be a lot more cautious spending this holiday. To me, 2027 is a squeeze. It's just a squeeze in so many areas on the economy. I don't predict recession, but it seems very optimistic that we could have a 2% year in 2027 with all these headwinds.

19:53 This is The Big Take from Bloomberg News. I'm Sarah Holder. To get more from The Big Take and unlimited access to all of Bloomberg.com, subscribe today at Bloomberg.com slash podcast offer. If you liked this episode, make sure to subscribe and review The Big Take wherever you listen to podcasts. It helps people find the show. Thanks for listening. We'll be back tomorrow.