Setting The Stage For October

Part of the answer is that Asian investors (Singapore really matters here, as of course does Korea) are joining the party and buying US equities ... the US data shows ~ $250b in equity inflows from the big East Asian economies

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But as should be very obvious from the graphs, and as Setser notes, the switch from bonds to equities is only a part—and not a very large part—of that missing flow. The US has long relied on foreign investors buying treasuries, and that’s not longer happening as reliably as in the past. This is a disaster for US interest rates. And there’s no reason to think that the rise in interest rates will stop before the midterms.

Trump continues to gaslight the American public—or tries to—regarding how he’s going from one victory to the next against Iran. I’m genuinely curious whether he believes this line about how ‘Iran will collapse after the midterms, so just vote for me,’ or whether he’s simply cynically attempting to jawbone the price of oil down a bit to somehow sneak past the midterms. And then try to figure out some sort of exit. As John Mearsheimer is fond of saying, the MOU was a surrender document that Trump signed, but now he’s trying to back out of it—but Iran keeps insisting on its terms. Which shows that Trump’s word is worthless—not worth the paper he signs. Like Mearsheimer I’m deeply skeptical of the escalation-after-the-midterms narrative:

Trump: Uh, well, I’m rejecting their deal. They want to make a deal where they open the strait immediately because they’re losing so badly. You know, you don’t read that or you don’t see that in the fake news. But we’re winning tremendously. We have total control of the Hormuz Strait.

Every time he says something like that Iran does something to give the lie to Trump’s schtick:

The Hormuz Letter @HormuzLetter

Sep 26

BREAKING: Trump announces he has officially rejected Iran’s proposal for a 7-day ceasefire to restart negotiations and has told his negotiating team that a return to the memorandum of understanding with Iran is now not possible at all.

Trump says lifting sanctions would give Iran room to maneuver, and that in any potential future agreement there will be no deal without Iran acting first.

Iran’s position is that the US must meet all of its conditions in a single step before anything else, and it said yesterday it will no longer negotiate over its nuclear program at all. Iran says it will not move first until the US does so, and Trump says there will be no deal without Iran moving first.

BREAKING: Iran has launched anti-ship missiles from Sirik in southern Iran toward vessels under US escort in the US-backed southern Omani corridor of the Strait of Hormuz, with several large-scale explosions heard …

BREAKING: Iran’s IRGC has substantially escalated its targeting of vessels in the Strait of Hormuz over the past hours …

BREAKING: Iran is laying naval mines in the US-backed southern Omani corridor of the Strait of Hormuz tonight. …

BREAKING: Iran’s IRGC announces it has seized a second US underwater drone in the Strait of Hormuz, a US Navy Remus 600, with the drone now in IRGC experts hands to retrieve its data and reverse engineer it.

The Remus 600 is a mine countermeasures vehicle, the type the US Navy uses to hunt and map naval mines.

It was captured right after Iran spent last night laying mines in the US-backed southern Omani corridor.

It is the second US underwater drone Iran has taken at the entrance to the Strait in three weeks, after the Anduril Dive-LD captured on September 8.

BREAKING: Iran announces it struck 19 vessels in the Strait of Hormuz over the past two nights, the largest attack on shipping of the war, with 7 vessels targeted last night and 12 the night before, per Fars. …

1h

BREAKING: Iran directly rejects Trump’s claim today that talks with Iran will happen this week, and Axios’s claim that another round would begin on Monday, per Fars.

Iran says the goal of Trump’s claims and US media outlets regarding unsubstantiated news about negotiations is “to prevent an increase in oil prices, which would benefit Trump ahead of the US elections.”

Again, I believe we can expect more of the same over the next month, leading up to the elections. Or perhaps even more. At any rate, with those data points in mind, here’s Sean Foo—for the most part:

Trump Just BROKE the Global Economy as Germany CUTS Off US Investments

Trump just did it again. The world economy is on the brink of a serious breakdown, but he still doesn’t want to make any kind of deal [with Iran]. We’re back into his massive all or nothing gamble. The energy crisis has already lasted for far too long for anyone to really absorb. But Trump still thinks waiting Iran out is the right approach.

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That decision is simply hard to comprehend given the current damage we’re seeing. According to the WSJ, Iran was genuinely open to a 7-day ceasefire [but under tough conditions]. They were willing to trade certain sanctions relief in exchange for reopening the strait of Hormuz. ... That sounds like a reasonable starting point for any negotiation. But Trump rejected it and even suggested continuing to bomb Iran after the US midterm elections. Understand exactly what that is going to mean for the next several months. From now until well into 2027 things are going to escalate even further because Trump is still obsessed with his maximalist demands. There’s no off ramp available.

This rejection just guarantees two continuing and very damaging responses from Iran going forward. The calculus here is not complicated at all. Iran is going to keep ramping up the oil crisis … to ramp up US inflation even higher. This has been the evident strategy for months and it’s clearly working. We only need to look at what’s happening in US financial markets to confirm that the strategy is succeeding. Ghalibaf himself knows exactly what the plan is. He even congratulated the US on a 10-year yield hitting 5.1%. The strategy is to push US interest rates back towards the levels of the 1970s. Now, for historical context that was when the 10 year yield went from 5% all the way past 12%. But there’s one enormous difference between the US of the 1970s and the US of today. In the 1970s US Debt to GDP was under 40%. Today it’s over 100%. Back then the deficit was only 1 to 2% of GDP. Today it’s hitting 6% at the very least. So this trajectory is unsustainable. Every serious investor and central banker understands exactly how Iran is going to push rates towards those 1970 levels: By maintaining the closure of Hormuz and hitting oil infrastructure across the region. It isn’t complex at all. You just need consistency in execution to win a war of economic attrition over time.

Diesel prices in the US have already hit $6.50 per gallon, a level never seen before in US history. And, since 2020, diesel prices have almost tripled in total. As we mentioned before, this seeps into the entire inflation structure of the US economy. Trump is still blaming the Russia Ukraine war for taking out oil refineries, but he refuses to connect the obvious dots about the much larger supply disruption from Hormuz. At least 1.5 million barrels of refined fuelincluding diesel flows through the strait. When you close that off, global refineries are forced to work overtime just to compensate. They need more crude to run at higher capacity. So crude prices are going to rise further, but there are fewer than 900 refineries in the entire world including those in the US and China combined. So the supply crunch is going to develop on the refining side as well. And that’s why it’s not just the US that’s in trouble. Every country on earth is getting pushed towards a breaking point from this crisis. Especially if you’re a country without easy access to domestic energy--like Korea, Japan or most of Europe.

Philip Pilkington suspects that the huge refinery outage near Chicago came about for exactly that reason—it was being operated past its breaking point in an effort to make up for diesel shortages. I’ve heard nothing about when that will be fixed.

Global oil inventories are dropping at a pace never seen before. We have gone from 8.3 billion barrels before the war started heading down to just 7.8 billion. The world is desperately drawing down their strategic stockpiles just to keep prices from exploding even higher. But there is a hard line on how long this can continue before prices switch direction. Countries like China and the US will need to refill their depleted oil stockpile sooner or later, regardless of price. Beijing has already added 200,000 barrels per day to their reserves in July alone. They’re not just buying for immediate consumption or refining. They’re stockpiling their reserves in case this war drags well into 2027 or even 2028. Meanwhile, the US is also in a very difficult position. The Strategic Petroleum Reserve or SPR has fallen to just 285 million barrels. Only around 33 million barrels can be released to stabilize global prices--and that’s essentially nothing, given the scale of the shortfall. That amount covers only 3 to 5 days of the missing oil supply from Hormuz. There’s actually a serious chance the US will have to start refilling the SPR themselves very soon, whether through buying domestic production or importing. That refilling will constrict available supplies even further.

Stockpiling US super light crude will do nothing for the growing diesel shortage. Moreover, the US will have great difficulty importing sufficient crude that’s suitable for US refineries to turn into diesel fuel. A significant source for that is the Persian Gulf.

This is a horrifying situation for a world not remotely ready for a more prolonged inflation crisis. If not for the AI spending bubble holding up US GDP numbers, we would very likely would be in a global recession. If we look at every bond market across the G7 and the Western world, the trend is undeniable. Bond yields are flying higher across the board and they’re squeezing all of these economies. The world is being pushed towards a point where high inflation and rising rates are both hammering economic growth at the same time. The problem with a sustained inflation crisis is how it directly pushes countries to face higher borrowing costs. When energy prices spike, countries that are net energy importers come under severe pressure.

This is very true for Japan and Korea, who import the vast majority of their energy needs. And despite all the interventions done to save the Japanese yen by both Tokyo and Bessent, the yen keeps weakening. The reason is simple. The longer the Hormuz crisis persists, the more money Japan needs to spend importing energy. So more yens get converted to dollars to buy fuel. The structural selling pressure on the yen never stops--the yen is crashing back towards 160 to the dollar again. This creates a massive and familiar problem for the US. Japanese rates have to rise and, as a consequence, more treasuries could get sold to fund the intervention. US yields could go even higher as a direct result. And this time Bessent simply cannot come in with another intervention to save the day. The US cannot sell dollars themselves without making the dollar’s problem even more visible and damaging.

And Europe, well, they weren’t happy about the previous yen intervention either. Germany’s central bank and EU policy makers scolded Bessent for dumping euros to save the yen. Instead of using the US currency to rescue an ally through proper channels, the US threw Europe under the bus to protect its own bond market. This is a powerful reminder that Europe is essentially alone in this new global order. And we don’t need to look far for the cause of this breakdown in trust. Just a few years ago, we all remember the Nordstream pipeline explosion. It cut Europe away from cheap Russian gas.Europe became very dependent on expensive US LNG to survive their energy crisis. Not really to “survive”--they’re suffering even more! And that enormous price difference that they paid is just taking the competitiveness of the German industry. Germany is still deep in the middle of a painful de-industrialization process. Volkswagen, which is the biggest industrial employer in the entire country, is going to cut 100,000 jobs. And that number could keep rising as energy costs keep undermining their position globally. …

Trump is now signaling a formal breakaway from Germany’s unconditional relationship with the United States. The foundational postwar World War II alliance structure is effectively ending under this administration’s management. And if you’re Germany, you have relied heavily on the US defense umbrella for decades. But Trump has threatened to pull over 5,000 troops from German soil over the next 12 months. A further withdrawal of weapon systems is also possible if Trump needs ammunition for Iran or simply wants to make a point. As a direct result, Germany has no choice but to invest urgently back into their own country and capabilities. German direct investment into the United States has plunged by a staggering 62% in the first half of this year.German companies only committed $5 billion so far. There are simply too many risks to justify building factories on American soil just for the US domestic market. You have expensive energy. You have punishing tariffs and the highest interest rates in decades. That really makes the US not cost competitive at all, especially for industries. Germany and the rest of Europe are also actively exploring new energy sources from Canada and elsewhere. So, putting their industrial future inside the US system simply does not make strategic sense anymore.

The more Trump lashes out at allies, the more it’s going to accelerate the alienation of countries like Germany from the US orbit. There are growing calls from German lawmakers to do something drastic. They want Germany’s gold reserves--currently stored inside the United States--to come home. Now, Germany holds over 200 tons of gold in the vaults of the New York Fed. That’s nearly $200 billion worth of physical gold sitting within the United States. This arrangement dates back to the Cold War, post World War II, and the Bretton Woods era. But does it really make rational sense for Germany to hold their national gold inside the US today? And if Germany follows the Netherlands or France and starts repatriating their gold back to Europe, it’s going to send a devastating signal about US credibility globally.

And speaking of credibility, very little of that remains in the US bond market. The US most recently bought back $4 billion worth of bonds through their market operations, the bond buyback program. Bessent was prepared to buy as much as $6 billion in long dated bonds, but investors offered to sell over $10 billion worth of treasuries back to him. Why are investors rushing to dump their bonds, even at a loss? Because they’re afraid that things will only get worse from here. They’re afraid of bond values cratering even further. There’s no guarantee that inflation will not keep climbing with the war ongoing. Many central banks are already buying gold aggressively and they’re not going to stop that program anytime soon. They watched what happened to Russia’s frozen assets. They watched the debacle unfolding with Iran’s financial isolation. And the conclusion they’ve reached is universal and rational: Holding fewer US bonds and acquiring more neutral assets that cannot be confiscated or devalued is really a good decision now.

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If this level of financial exclusion can happen to Iran today, it could happen to any country tomorrow. What if it’s China next and global companies suddenly cannot deal with Chinese counterparts or risk getting kicked out of the dollar system entirely? That existential fear is driving the broad global move away from US assets. Now even retail investors are starting to shift their behavior in response to all these signals, except they’re moving away from treasuries and they’re piling into US equities instead. This is pushing stock valuations to nose bleed levels that still persist today. And if you’re wondering why US stocks haven’t collapsed yet despite bond yields going up, this is probably why. Foreigners are still piling into US technology stocks. They’re buying the S&P 500 because they believe Trump will keep the AI bubble hype inflating to avoid a recession, and there’s a real chance he’s going to do that. Trump has abandoned all AI safeguards--the entire plan for him is full steam ahead to ensure the US does not lose a tech race against China. But this also sets investors up for a big shock directly tied to where interest rates go from here. We’re sitting inside one massive speculative bubble across multiple interconnected asset classes. Things could get very ugly very fast if rates keep rising. All it takes is one major hyperscaler stopping or reducing the data center buildout. And that single event could be game over for the entire narrative holding markets up right now.

From 2025 through 2031, total AI infrastructure investments are expected to average over 3.6% of US GDP annually. That is what the entire economy and all the financial markets are pricing in. They believe that is a certainty. Now imagine what happens if that spending program stops or slows dramatically. We could see the US economy enter a rapid recession. Markets would panic if the AI buildout stalls for any sustained period. So just because stocks are rising while US bonds are falling does not mean equities are a safe haven asset. It’s all one big interconnected casino right now.

Look for an eventful October.