Inflation Episodes, Act III: When the Fire Brigade Brings Kerosene

Where were we?

Ah, yes…

The Fed ended Quantitative Tightening (QT) on Monday, and all week we’ve been circling the same question like a vulture over a warm highway: What does it mean when the fire department announces it’s out of water just as the dry season starts?

QT is over. Rate cuts are next. And in an inflationary world, that combo is gasoline on embers.

Today, four moving parts are telling the same uneasy story: a Fed boxed into cutting to save the consumer, a bond-market quake in Japan, a divergence between bitcoin’s excitement and the real economy’s pulse, and a massive “all-in” bet against long-term Treasuries that could unwind in biblical fashion.

Let’s begin where Americans feel the squeeze most acutely — home.

The Fed Must Cut—But Cuts Will Not Help Those Who Need It Most

Bankrate asked Americans if they could cover a $1,000 emergency. Only 41% said yes. The other 59% would need to borrow, sell something, or improvise.

This is the quiet truth behind the affordability crisis.

Stocks can be euphoric, Nvidia can moonshot, bitcoin can levitate, but more than half the country isn’t participating — not because they don’t want to, but because every dollar they touch is already spoken for.

Here’s the disturbing break:

Before 2020, consumer confidence rose and fell almost in tandem with the stock market. Now the lines move in opposite directions. Confidence is sinking as stocks rise.

Why? Because rising asset prices feel like financial salvation if you own assets… and like a taunt if you don’t.

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Mark Jeftovic calls it the “great bifurcation,” and from this chart, it looks like it’s here… fears of AI taking away jobs and runaway inflation in housing, healthcare and tuition are already affecting those who can’t balance expenses against rising assets. (Source: Bianco Research, LLC)

Today, the top 10% of earners account for half of all U.S. consumer spending. Rate cuts that boost stock prices inflate the purchasing power of the wealthy while widening the gulf for everyone else.

How does fattening the brokerage accounts of the top decile fix affordability?

It doesn’t.

But the Fed must cut because the bottom half of America is already showing signs of breaking. If the Fed doesn’t relieve debt pressure, the consumer cracks. If it does relieve it, inflation cracks upward instead.

Policy makers are stuck and must choose between failure modes.

Japan: The Quiet Catastrophe Stopped Being Quiet

On Tuesday, Japan’s 10-year yield hit 1.92% — its highest since 2007. In 2019, it was negative 0.28%.

That 220-basis-point swing is the bond market making a loud statement.

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We’ve had one eye on the Japanese bond market since writing the chapter about Japan, demographics and societal debt in the first edition of Financial Reckoning Day (2003). Looks like some of those chickens are coming home to roost. (Source: The Kobeissi Letter)

Japan is raising rates into a $135 billion fiscal stimulus package — tightening monetary policy while detonating fiscal spending inside a nation already running 255% debt-to-GDP. No sovereign in history has successfully pulled this off.

Debt service already consumes nearly a quarter of Japan’s tax revenue. Push yields past 4%, and the math ends in collapse.

And here’s why this isn’t a Japanese problem:

For 20 years, the global carry trade depended on borrowing yen at zero to fund positions everywhere else. Hedge funds. Pension funds. Sovereign wealth funds. Trillions in leverage were built on the assumption that the BOJ would freeze rates forever.

That assumption was officially laid to rest this week.

If Japan becomes a forced seller of foreign assets to defend its own market, there will be no buyers at scale. Global markets won’t “correct.” They’ll gap.

For big institutional players — every dollar in your retirement account — was built atop a world that no longer exists.

₿ Bitcoin Is Screaming — But M2 Velocity Is Whispering “Slow Down”

Bitcoin’s taker buy/sell ratio has surged to 1.17, signaling aggressive buying. That looks bullish. But in crypto, “urgent buying” often translates to “leveraged buying” rather than fresh fundamental capital.

Meanwhile, M2 velocity — the speed at which money circulates through the economy — has flattened after a brief post-COVID rebound.

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M2 Velocity behaves like a long, smooth tide. It rises when the economy accelerates. It rolls over when momentum fades. Right now, it’s flattening. (Source: St Louis Fed)

As a measure of economic activity, M2 slowing down and flattening out is what late-cycle periods look like: risk assets become excitable while real economic currents grow quiet. Bitcoin’s enthusiasm may be a mirage powered by leverage, not by broad economic confidence.

When those diverge, the rallies are fast — and the reversals are faster.

TLT Headed for a Short Squeeze?

Here’s an interesting twist:

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Any time the shorts pile in on one side of a trade, it makes the hairs on the back of our neck feel itchy. That shorts on TLT are at a historic high actually gives us a good entry point, as we indicated on Tuesday. (Source: Barchart)

Short interest in TLT — the long-duration Treasury ETF — has reached an all-time high.

Because the U.S. government is digging the largest financial hole of any government in human history – $38 trillion in national debt – traders are piling into one bet: long-term bond prices will keep falling.

But… if the Fed cuts and growth slows further, long-dated yields could drop sharply. When yields fall, TLT rockets.

That would force every short to buy back shares at once — creating a violent feedback loop known as a “short squeeze.”

Complicating matters: a huge percentage of the short interest isn’t even directional. It’s dealers hedging call options, meaning one sharp move could force them to become buyers in size.

In short: the market has built a bonfire directly beneath the part of the financial system designed to put fires out.

The Thread That Ties It All Together

We’ve been getting this question a lot more frequently than usual: What will the next crisis look like? And when?

If you squint, you can already see the silhouette.

It won’t arrive as a single dramatic blow, but as the cumulative weight of a system that can’t normalize — an economy where consumers are tapped out, the Fed is cornered into cutting with inflation still warm, Japan just cracked the global carry trade, and money now moves at the speed of software.

The next crisis will look less like 2008 and more like 2008 accelerated: faster panics, faster exits, faster contagion.

If Dollar 2.0 becomes the preferred escape hatch when trouble arrives, we’ll discover just how quickly digital dollars can drain a bank and how few tools the Fed has left besides — once again — turning the printers back on.

Think Enron, but in real time, with fewer guardrails and a public far less forgiving.

We’re not there yet. But the questions people are asking tell you everything: they can feel the floorboards flexing. The job now isn’t to predict the exact spark— it’s to recognize the room is already full of smoke.

The contrarian bet: the U.S. dollar, now at a 15-year low, rebounds and Treasurys reassert themselves as the historic “flight to safety” trade.

In that scenario, even gold and silver are subject to panic selling as investors rush to dollars.

But that’s usually what happens near the end of a crisis – even gold, which soared in 2007 and 2008, succumbed to the rush to liquidity near the end of that meltdown – and a good contrarian sign to pick up precious metals at a reasonable dollar price.

If that plays out, expect policymakers to overreact and flood the system – it’s all they know how to do. And then the real market meltup – a Terrifying Bull market goosed by money printing, devoid of fundamentals – will be on.

~Addison

P.S. Today at 2 p.m. EST on Grey Swan Live! I’m dragging Dan Denning — Bill Bonner’s longtime investment partner, master of macro mayhem — back into the ring.

We’ll be hashing out the end of QT, the rise of Dollar 2.0, and what the next phase of this bubble machine means for your balance sheet. Bring a stiff drink and sharper questions. Dan always does.

Turn Your Images On

If you have requests for new guests you’d like to see join us for Grey Swan Live!, or have any questions for our guests, send them here.

Where were we?

Ah, yes…

QT is over. Rate cuts are next. And in an inflationary world, that combo is gasoline on embers.

Let’s begin where Americans feel the squeeze most acutely — home.

The Fed Must Cut—But Cuts Will Not Help Those Who Need It Most

Bankrate asked Americans if they could cover a $1,000 emergency. Only 41% said yes. The other 59% would need to borrow, sell something, or improvise.

This is the quiet truth behind the affordability crisis.

Here’s the disturbing break:

Before 2020, consumer confidence rose and fell almost in tandem with the stock market. Now the lines move in opposite directions. Confidence is sinking as stocks rise.

Why? Because rising asset prices feel like financial salvation if you own assets… and like a taunt if you don’t.

Turn Your Images On

Today, the top 10% of earners account for half of all U.S. consumer spending. Rate cuts that boost stock prices inflate the purchasing power of the wealthy while widening the gulf for everyone else.

How does fattening the brokerage accounts of the top decile fix affordability?

It doesn’t.

Policy makers are stuck and must choose between failure modes.

Japan: The Quiet Catastrophe Stopped Being Quiet

On Tuesday, Japan’s 10-year yield hit 1.92% — its highest since 2007. In 2019, it was negative 0.28%.

That 220-basis-point swing is the bond market making a loud statement.

Turn Your Images On

Debt service already consumes nearly a quarter of Japan’s tax revenue. Push yields past 4%, and the math ends in collapse.

And here’s why this isn’t a Japanese problem:

That assumption was officially laid to rest this week.

If Japan becomes a forced seller of foreign assets to defend its own market, there will be no buyers at scale. Global markets won’t “correct.” They’ll gap.

For big institutional players — every dollar in your retirement account — was built atop a world that no longer exists.

₿ Bitcoin Is Screaming — But M2 Velocity Is Whispering “Slow Down”

Meanwhile, M2 velocity — the speed at which money circulates through the economy — has flattened after a brief post-COVID rebound.

Turn Your Images On

M2 Velocity behaves like a long, smooth tide. It rises when the economy accelerates. It rolls over when momentum fades. Right now, it’s flattening. (Source: St Louis Fed)

When those diverge, the rallies are fast — and the reversals are faster.

TLT Headed for a Short Squeeze?

Here’s an interesting twist:

Turn Your Images On

Short interest in TLT — the long-duration Treasury ETF — has reached an all-time high.

But… if the Fed cuts and growth slows further, long-dated yields could drop sharply. When yields fall, TLT rockets.

That would force every short to buy back shares at once — creating a violent feedback loop known as a “short squeeze.”

Complicating matters: a huge percentage of the short interest isn’t even directional. It’s dealers hedging call options, meaning one sharp move could force them to become buyers in size.

In short: the market has built a bonfire directly beneath the part of the financial system designed to put fires out.

The Thread That Ties It All Together

We’ve been getting this question a lot more frequently than usual: What will the next crisis look like? And when?

If you squint, you can already see the silhouette.

The next crisis will look less like 2008 and more like 2008 accelerated: faster panics, faster exits, faster contagion.

Think Enron, but in real time, with fewer guardrails and a public far less forgiving.

The contrarian bet: the U.S. dollar, now at a 15-year low, rebounds and Treasurys reassert themselves as the historic “flight to safety” trade.

In that scenario, even gold and silver are subject to panic selling as investors rush to dollars.

~Addison

P.S. Today at 2 p.m. EST on Grey Swan Live! I’m dragging Dan Denning — Bill Bonner’s longtime investment partner, master of macro mayhem — back into the ring.

We’ll be hashing out the end of QT, the rise of Dollar 2.0, and what the next phase of this bubble machine means for your balance sheet. Bring a stiff drink and sharper questions. Dan always does.

Turn Your Images On

If you have requests for new guests you’d like to see join us for Grey Swan Live!, or have any questions for our guests, send them here.

Back in April, when we published what we called the Trump Great Reset Strategy, we described the grand realignment we believed President Trump and his acolytes were embarking on in three phases.

At the time, it read like a conceptual map. As the months passed, it began to feel like a set of operating instructions written in advance of turbulence.

As you can expect, any grandiose plan would get all kinds of blowback… but this year exhibited all manner of Trump Derangement Syndrome on top of the difficulty of steering a sclerotic empire clear of the rocky shores.

The “phases” were never about optimism or pessimism. They were about sequencing — how stress surfaces, how systems adapt, and what must hold before confidence can regenerate. And in the end, what do we do with our money?!

Relative to GDP, the net international investment claim on the U.S. economy was 20% in 2003. It had swollen to 65% by 2023. Practically every type of American company, bond, or real estate asset now has some degree of foreign ownership.

But it’s even worse than that. As the federal deficit has pumped up the GDP figures, and made a larger share of the economy dependent on government spending, the quality and sustainability of GDP have deteriorated. So, foreigners, to the extent they are paying attention, are accumulating claims on an economy that has been eroded by inefficient, government-directed spending and “investments.” Why should foreign creditors maintain confidence in the integrity of these paper claims? Only to the extent that their economies are even worse off. And in the case of China, that’s probably true.

As global government interest expense climbed, gold quietly followed it higher. The IIF estimates that interest costs on government debt now run at nearly $4.9 trillion annually. Over the same span, gold prices have tracked that burden almost one-for-one.

Silver has recently gone along for the ride, with even more enthusiasm.

Since early 2023, Japan’s 10-year government bond yield has risen roughly 150 basis points, touching levels not seen since the 1990s.

Over that same period, gold prices have surged about 135%, while silver is up roughly 175%. Zoom out two years, and the divergence becomes starker still: gold up 114%, silver up 178%, while the S&P 500 gained 44%.

According to the American Association of Individual Investors, the average retail investor has about a 70% allocation to stocks. That’s well over the traditional 60/40 split between stocks and bonds. Even a 60/40 allocation ignores real estate, gold, collectibles, and private assets.

A pullback in the 10% range – which is likely in any given year – will prompt investors to scream as if it’s the end of the world.

Our “panic now, avoid the rush” strategy is simple.

Take tech profits off the table, raise some cash, and focus on industry-leading companies that pay dividends. Roll those dividends up and use compounding to your overall portfolio’s advantage.

Back in April, when we published what we called the Trump Great Reset Strategy, we described the grand realignment we believed President Trump and his acolytes were embarking on in three phases.

At the time, it read like a conceptual map. As the months passed, it began to feel like a set of operating instructions written in advance of turbulence.

Silver has recently gone along for the ride, with even more enthusiasm.

Since early 2023, Japan’s 10-year government bond yield has risen roughly 150 basis points, touching levels not seen since the 1990s.

A pullback in the 10% range – which is likely in any given year – will prompt investors to scream as if it’s the end of the world.

Our “panic now, avoid the rush” strategy is simple.

Take tech profits off the table, raise some cash, and focus on industry-leading companies that pay dividends. Roll those dividends up and use compounding to your overall portfolio’s advantage.