Warsh lets bond yields rise to tighten credit
- Kevin Warsh is letting long-term bond yields spike to cool the economy without formal Fed rate hikes.
- Unpriced nominal growth and 10% M2 money expansion leave bond yields lagging behind economic reality.
- Margin calls and fund liquidations in AI stocks are driving capital back into liquid crypto markets.
Kevin Warsh is not waiting for a formal Federal Reserve rate hike. He is letting the bond market do the tightening for him.
Rather than pushing for politically contentious rate hikes at short-term Fed meetings, incoming economic leaders are targeting the long end of the yield curve. By pulling back support for long-dated Treasuries, Warsh is allowing 30-year yields to rise toward fair market value. Higher long-term yields automatically restrict corporate borrowing and cool the housing market, accomplishing the central bank's inflation goals without the friction of an official vote.
The economic baseline was already primed for higher yields. On TFTC, Michael Howell pointed out that U.S. nominal GDP growth between 6% and 7% left a massive 200-basis-point gap with lagging 10-year Treasury yields. With three-month annualized M2 money supply growth recently touching 10%, artificial suppression of bond volatility was merely hiding persistent inflationary pressure under heavy fiscal expansion.
That volatility suppression required systemic trade-offs. The U.S. Treasury was funding 80% of its gross issuance in short-term bills under two years, forcing commercial banks to expand their balance sheets to absorb short-dated debt. This structure effectively monetized the deficit and depressed long-term yields by at least 50 basis points. Withdrawing that support forces the market to price real risk, but it also triggers sharp forced liquidations across leveraged trades.
Those liquidations are already hitting overextended technology assets. Four days later on Forward Guidance, the unwind accelerated when Citadel stepped in to buy out the forced liquidation of Leopold Aschenbrenner's Icorus fund at distressed lows. The sharp drop in AI chip names was driven by systematic margin calls against fund positions rather than deteriorating corporate earnings, exposing how much borrowed money had inflated sector valuations.
A day later on Bankless, discussions focused on how localized liquidity shocks are testing regional rails. When President Yoon Suk Yeol declared martial law in South Korea, panic selling created a $30,000 discount on local exchanges compared to global spot Bitcoin. Despite the Korean crash, broader crypto markets held firm, leading analysts to argue that capital is actively rotating out of fragile AI equities into hard liquid assets.
The era of artificial market suppression is ending. Borrowers and leveraged funds will have to adjust to the true cost of capital.
Source Intelligence
- Deep dive into what was said in the episodes
The AI Unwind And Warsh's Long-End Gamble | Weekly Roundup • Aug 3
- Quinn notes that GDP data for Q2, while missing consensus at 1.5% (vs. 2.1%), showed strong personal consumption expenditure and real final sales to private domestic purchasers, indicating core economic strength despite a net export drag.
Also from this episode: (13)
Markets (5)
- The AI trade unwind saw Leopold Ashbrer's fund, which grew from an initial $225 million to billions, forced to liquidate its public and some private market positions, with Ken Griffin's Citadel reportedly buying the assets.
- The Host notes that the AI trade's prior growth was heavily driven by leverage, including 3x retail ETFs and Korean margin calls, suggesting that a return to peak levels would be difficult without similar leverage.
- Quinn points out that the first meaningful earnings miss from SK Hynix coincided with maximum leverage in the system and increased short-selling activity by firms targeting large, vulnerable players.
- The Host emphasizes that market price often drives narrative, rather than the reverse, evidenced by varied explanations for the AI trade's decline until leverage liquidations became the clear cause.
- Quinn highlights that while nominal yields across the curve didn't show the full picture, the 30-year duration saw higher real yields, aligning with the argument that the long end has been suppressed by Fed intervention.
Fed (6)
- The Fed, led by Kevin Worsh, paused interest rate hikes with three dissents, despite market odds suggesting a 60% chance of a pause and 40% for a hike, unsettling bond investors with perceived communication issues.
- Nick Timiraos, citing Marabana from Bank of America, characterized the Fed's communication as a 'classic central bank credibility shock,' causing the long end of the curve and stocks to turn as investors doubted the chairman's willingness to deliver further hikes.
- Kevin Worsh's press conference unsettled investors due to uncertainty regarding the Fed's inflation gauge, with Worsh stating his own 'lens is broader' than the official PCE and suggesting the central bank's strategy statement could change.
- The Host argues that Worsh clearly signaled a desire to remove balance sheet accommodation from the long end of the Treasury market to allow free market pricing, which would restrict financing conditions and widen credit spreads.
- The Host asserts that Worsh's strategy implies that allowing the long end to reprice higher by 50-100 basis points, without direct rate hikes, would sufficiently slow the economy and inflation, making aggressive front-end hikes unnecessary.
- Quinn speculates that by avoiding a hike today, the Fed is making a bet that tightening financial conditions through long-end focus, combined with external factors like the Iran war, will stabilize the economy by the September meeting, allowing them to avoid a pre-midterm hike.
Macro (1)
- The Host believes many 'big boosts' to growth, such as the World Cup, 'one beautiful bill' stimulus, and stock market wealth effects, are evaporating, suggesting growth estimates will likely decline over the next two to three quarters.
Politics (1)
- The Host suggests that the current administration has a history of creating volatility events to achieve policy goals and will likely manufacture favorable outcomes, especially as midterms approach, rather than maintaining long-term hawkish resolve.
ROLLUP: Korea Gets Liquidated | The AI Trade Unwinds | Crypto Holds Firm | Warsh Holds Rates • Jul 31
Also from this episode: (10)
BTC Markets (3)
- Martial law in South Korea triggered a crypto flash crash, causing a 'reverse Kimchi premium' where Bitcoin traded at a $30,000 discount on Upbit.
- David Hoffman states the Korean panic selling was a desperate grab for liquidity in a closed system, not a critique of Bitcoin's value. Local market makers could not arbitrage the price gap.
- This market decoupling suggests Bitcoin is maturing into a distinct asset class, no longer merely a high-risk proxy for the Nasdaq.
Markets (3)
- Global crypto markets remained largely unaffected by the Korean flash crash, highlighting the growing disconnect between local shocks and global crypto resilience.
- The correlation between Big Tech and Bitcoin is fracturing; Nvidia and other 'Magnificent Seven' stocks show exhaustion while crypto holds its local highs.
- Ryan Sean Adams argues a structural rotation is underway as the 'AI trade' unwinds into the 'crypto trade.' Speculative capital is returning to on-chain markets.
Fed (3)
- Kevin Warsh's potential role at the Fed or Treasury is resetting market expectations for 2025, given his historically hawkish monetary policy stance.
- The market's reaction to Warsh's hawkish signals has been calm, despite high rates typically creating headwinds for risk assets.
- If the Fed maintains 'higher for longer' rates to combat inflation, Bitcoin’s role as a hard-money hedge becomes central to institutional investment theses.
Politics (1)
- David Hoffman suggests Warsh represents a 'professionalization' of Trump's economic agenda. The market prefers a predictable hawk over a chaotic dove.
Marty Bent
#776: Yields Must Rise, Fed Must Hike with Michael Howell • Jul 30
- The US economy's nominal growth, estimated between 6% and 7% (and possibly higher due to AI spending), suggests current 10-year yields are unsustainably low. Howell notes a historical gap of over 200 basis points between nominal GDP and the 10-year bond.
- Michael Howell reports that the three-month annualized M2 money supply growth was recently near 10%, indicating future inflation issues. This expansion is attributed to robust nominal GDP growth, AI capital expenditure, and large fiscal deficits.
- Michael Howell notes the global liquidity cycle's growth rate slowed around Q3 last year, diverting money from financial markets into the real economy. This typically leads to flattening yield curves, a normal cycle in robust economic conditions.
- Michael Howell states that the US government's current debt funding model involves 80% of gross issuance under two years duration, a practice he compares to Latin American economies. Other nations are adopting similar short-term funding strategies.
Also from this episode: (6)
Markets (1)
- Michael Howell observes deliberate manipulation of bond market volatility, which he terms "yield volatility control." This policy uses short-term issuance and Treasury buybacks to suppress yields, potentially by 50 basis points on the 10-year note.
AI & Tech (1)
- An AI system analysis by Michael Howell indicates that the two-year Treasury yield's signals for Fed policy are correct 85-90% of the time. The current spread suggests accelerating monetary tightening, tracking the 2021-2022 period.
Fed (1)
- Michael Howell explains that during the 2021-2022 monetary tightening, the S&P 500 fell 25% and crypto assets fell 75%. He suggests risk assets like stocks have yet to discount the current projected tightening.
Macro (2)
- Michael Howell argues the world is in a "capital wars" regime, where governments actively boost national competitiveness, driving higher nominal GDP growth by 200 basis points. This shift diverts liquidity from financial assets to the real economy.
- Michael Howell indicates that an R-squared value above 32% links crypto basket variation to global liquidity changes, a powerful correlation in financial markets. Global liquidity accounts for about 45% of crypto's total price variation.
Inflation (1)
- Michael Howell asserts that governments will resort to printing money due to an inability to cut spending, reform welfare, or increase taxes without an exodus of talent (e.g., UK lost 600,000 millionaires since 2021).