S&P Global: Sharpest rise in service sector business activity since July 2021

The headline S&P Global US Services PMI^® Business Activity Index improved for the fourth successive month in September, rising to 58.8 from a reading of 56.5 in August. The index has now signaled increasing business activity in six consecutive months, with the latest expansion the most pronounced since July 2021.

For the first time in 10 months, output trended higher across all five broad sectors covered by the survey as transport & storage activity returned to growth. By far the sharpest expansion was seen in the information & communication sector, however.

The rapid increase in business activity was in line with a similarly-sized rise in new orders at the end of the third quarter. Here, the pace of growth quickened to the fastest in four-and-a-half years amid reports of particular strength in domestic demand. Although new export orders rose at a much slower pace than total new business, growth was recorded for the second consecutive month and the pace of increase was unchanged from August’s 20-month high.

With total new orders rising rapidly again in September and some companies able to fill previously vacant positions, workforce numbers increased for the third month running. Moreover,the rate of job creation was the fastest since June 2022.

Despite efforts to expand workforce capacity, the strength of the influx of new orders was such that volumes of backlogged work accumulated again, extending the current sequence of rising outstanding business to 19 months. Furthermore, growth strengthened since August, was the sharpest in almost four-and-a-half years and among the most marked on record.

Having eased to a 16-month low in August, input cost inflation accelerated sharply in September and was the steepest since November 2022. Higher gas prices and an associated rise in transportation costs were widely reported, with some respondents also mentioning increased labor costs. Similarly, output prices also rose at a faster pace, with inflation the second-fastest in just over a year (behind only July).

Having observed strong growth in business activity in September, service providers were increasingly optimistic that output will rise over the coming 12 months. In fact, sentiment hit a one-year high. Anecdotal evidence linked confidence to expected increases in new orders amid the introduction of new products, the securing of new clients and referrals from existing customers. Hopes for an easing of inflationary pressures were also mentioned.

Combined with the encouragingly solid manufacturing PMI, the strong service sector expansion points to economic growth of around 4% in the third quarter and 5% in September alone, the latter hinting at accelerating momentum into the fourth quarter.

Tech companies are reporting by far the strongest growth but the rising tide is now lifting all boats as far as the major sectors are concerned, with accelerating growth also reported for consumer-facing businesses as well as industrials and healthcare, alongside sustained solid growth in financial services.

• Technology sector growth accelerates to its fastest in over five years

All seven US sectors posted an expansion of business activity during September and the majority saw stronger growth than in August.

Industrials also outperformed at the end of the third quarter, with output growth accelerating to its fastest in over five years (index at 58.6, up from 54.5 in August).

September data indicated stronger momentum in both the Basic Materials and Consumer Goods sectors, with both registering robust rises in production volumes.

John Authers:

The 10-year Treasury yield, the most important number in global finance, has now broken through its high from 2007, when a bond sell-off triggered the Global Financial Crisis. It’s now the highest since 2002:

Services inflation is proving intractable, and the proportion of supply managers complaining about rising prices climbed to its highest since the post-pandemic surge. With the exception of a few months at the top of the oil price spike in 2008, and in the brief spasm that followed Hurricane Katrina in 2005, the reading is the strongest since the series began in 1997:

Bond yields are assumed to have an inverse relationship with stocks, so a move of this magnitude should be a problem for equities. It hasn’t been. (…)

Maybe it has been:

• The equal-weighted S&P 500 continues to lag the cap-weighted benchmark. The relative ratio’s deviation from trend is nearing levels last seen during the dot-com bubble.

From Almost Daily Grant:

Monday’s push above 5.3% for 10-year Treasury yields marked a new cyclical high, while posing a growing threat to a heretofore-bulletproof bull market in stocks. More than half the respondents to a Bloomberg investor survey conducted last month predicted that 5% to 5.5% on the 10-year would be sufficient to catalyze a 10% correction in the S&P 500. The benchmark yield stood near 4.8% at the time.

As nominal GDP expands at the fastest annual rate of the past two decades (exempting the post-Covid snapback) with the the 10-year breakeven inflation rate reaching 2.36% on Friday versus 2.21% in July,  the prospects of an overheating economy spurring more restrictive monetary policy grow increasingly realistic.

Those risks crystallize around a 2.5% 10-year breakeven rate, commensurate with roughly 5.5% on the 10-year Treasury, Bloomberg’s Edward Harrison writes today: “If yields get that high, inflation expectations are elevated and the economy is still booming, that would likely force a train of rate hikes like we saw in 2022.”

Meanwhile, seemingly inexorable selling pressure on long-dated debt could eventually elicit a drastic response from Washington. Terming a 6% 30-year yield – a level last breached in 2000 – as “inevitable,”  BMO Global Asset Management’s head of fixed income Earl Davis warned of a debt trap on Bloomberg Television this morning, whereby borrowing costs exceed nominal growth, spurring a vicious cycle of new borrowing just to service existing obligations.

Uncle Sam would not take such a development lying down. “It [would lead to] the Fed and Treasury working together to buy up bonds,” Davis hypothesized. “I think it is QE, without a doubt.”

While such a move would seemingly do little to contain the price pressures percolating over the past five-plus years, key constituencies evince little concern over such a potential trade off.  Behold a telling exchange from last week’s Time Magazine interview with President Trump:

Trump: Okay, and frankly, this [high rates] is hurting our country more than inflation is hurting our country. More than inflation.

Interviewer: Can you tell us about your meeting with…?

Trump: You know, inflation. Certain levels of inflation will also pay off that debt very rapidly. Very rapidly.

Following those remarks, White House communications director Steven Cheung interjected that the allotted one-hour interview time was nearly complete.

Canada: Activity and new business fall again as cost pressures intensify

Companies in Canada’s service sector continued to face a challenging business climate during September. Reflective of ongoing uncertainty due to tariffs and the war in Iran, both activity and new business fell, albeit at slower rates compared to August.

 

Tariffs and elevated energy/fuel prices also served to push up operating expenses more sharply, but strong competitive pressures restricted the degree to which firms could pass these on to clients and output price inflation fell to a seven month low.

Staffing levels were also reduced in response to lower activity and new business, although the downturn was exacerbated by difficulties in finding suitably skilled workers to fill vacancies.

Firms were nonetheless more confident in the outlook, with sentiment improving to its highest level since April.

Margins also came under renewed pressure as market competition restricted pricing power. With firms subsequently reluctant to replace any leavers at their units, the net result was a drop in employment for the first time since May.

Euro area growth hits strongest in almost three-and-a-half years

Demand for eurozone goods and services continued to improve in September, completing a full quarter of growth. Overall, the pace of increase ticked up to a 41-month high. Export* performances were supportive of this overall
demand expansion, with new orders from foreign clients rising at the sharpest rate in over four-and-a-half years.

The S&P Global Eurozone Services PMI Business Activity Index posted its highest reading since last November, rising from 51.6 in August to 53.0 in September. The latest figure – which was the third above the 50.0 no-change level in as many months – pointed to a sustained expansion in the euro area’s services economy.

New business intakes likewise rose for a third straight month in September. The rate of growth was the joint-strongest since last November (equal to July of this year and December 2025). Domestic customers were the main drivers of sales activity as new export volumes were unchanged from August.

The fastest growth of the service sector since last November indicates that the eurozone economic upturn is both accelerating and broadening out beyond manufacturing. The collective signal from the PMI surveys is one of GDP growing at a 0.4% quarterly rate, with momentum accelerating as we head into the fourth quarter.

While both Germany and France saw encouraging returns to growth of services activity for the first times since March and last December respectively, and Italy reported an expansion for a fourth successive month, the best performer by far was Spain, where a turbo-charged September rounded off its best quarter for five years.

Although the drivers of growth vary between countries, across the eurozone as a whole IT-related services are showing especially solid growth, buoyed by AI investments and supported by professional and commercial services growth.

Perhaps more surprising is the resilience of consumer-oriented services growth, given recent energy price hikes, notably driving the above-par growth in Spain.

A renewed upturn in price pressures signalled by the survey meanwhile hints at eurozone inflation running closer to 4% than the ECB’s 2% target. Combined with the acceleration of growth indicated by the PMI, the data will spur further speculation of more aggressive monetary policy tightening.

• Greatest number of sectors in growth territory since March 2023

September data signalled an expansion in output levels in 16 of the 19 monitored sectors, according to the latest S&P Global Europe Sector PMI®. This was the largest number of segments in growth territory since March 2023, up from 13 in August.

As has been the case for the last three months, Technology Equipment continued to register the steepest expansion in production in September. The rate of growth in output was the fastest in five years and marked overall. Similarly,
Software & Services recorded another sharp upturn in activity, as Technology remained the strongest performing broad category. (…)

Actually, not only is tech growth accelerating, it is spilling over most other sectors globally: “For the second month running, growth was signalled across each of the 21 sectors monitored by the S&P Global Sector PMI®. In fact, all but seven indicated faster expansions compared to August.”

As a result:

Global output rises at fastest rate for over three years

The upturn in global economic activity gathered momentum in September. Growth accelerated for the sixth month in a row to reach a 40-month high. The outlook also remained positive overall, with new order growth and business optimism about the year ahead both strengthening.

Economic activity and incoming new business rose across the six sub-sectors covered by the survey (consumer, intermediate and investment goods producers and business, consumer and financial service providers). Financial services registered the fastest rate of output expansion (despite being the only category to see growth slow) and consumer services the weakest.

12 out of the 15 nations for which September PMI data were available registered an increase in economic activity, with only Brazil, Kazakhstan and Canada seeing contractions. The US, Spain and India were at the top of the global PMI output growth rankings.

The level of incoming new business increased at the quickest pace since February 2022, with rates of expansion accelerating at manufacturers and service providers alike.

Part of the latest increase was underpinned by improved international trade flows, with new export business rising for the second successive month and to the greatest extent in over five years.

Business optimism about the year ahead rose to a seven-month high, with sentiment strengthening in the business services, consumer goods, consumer services and intermediate goods sectors. That said, the financial services category remained the most optimistic overall.

September data signalled an uptick in inflation, with rates of increase in both input costs and output charges accelerating.

Average input prices rose at one of the quickest rates in almost four years, beaten only during that period by the conflict-related highs seen in April and May of this year. Manufacturers and service providers both saw faster inflation of costs, with rates of increase hitting three- and 44-month highs respectively.

Part of the increase in input prices was passed on to clients in the form of higher output charges, with selling price inflation picking up from August’s six-month low. Rates of increase accelerated in both the manufacturing and services sectors.

The Surge in Rates Is Blowing Up Commercial Real-Estate Deals Property buyers are demanding sellers renegotiate terms because of higher mortgage rates, signaling broader market distress

A growing number of commercial real-estate buyers are threatening to walk away from recent transactions unless the seller offers better terms.

Rapidly rising interest rates are to blame.

Investors who agreed to a purchase price earlier this year when financing was cheaper are now demanding price cuts or other concessions before closing.  (…)

The typical six to 12 months between when a buyer signs a contract and when the sale is completed can make a substantial difference in financing costs when borrowing rates are rising as rapidly as they are now.  (…)

Commercial real estate—from offices in certain cities to shopping malls and hotels—had been enjoying a budding recovery. Reduced new supply, a pickup in workers returning to the office and a leveling off in interest rates in recent years helped boost property values.

Now, the sudden surge in interest rates is derailing that period of progress.

The fallout extends beyond property owners. Falling real-estate values and fewer sales squeeze property-tax and transfer-tax collections. Higher rates also make it harder for developers to earn their targeted returns. That cuts demand for construction workers, architects and building materials. (…)

Higher rates are also adding to landlord distress because mortgages made when borrowing costs were lower come due. Owners that can’t refinance or repay the loans at maturity are falling behind or being pushed into special servicing.

Data firm Trepp reported that in August, 11.42% of mortgages packaged into commercial mortgage-backed securities were being handled by special servicers, a sign that those loans were facing problems such as missed payments or difficulty refinancing at maturity. That is the highest special-servicing rate since February 2013.

It goes beyond real estate:

(…) Moody’s estimated last year that a record $1.45tn of US investment-grade corporate debt would come due between 2026 and 2030. Rising rates will put pressure on businesses to increase profits at a similar pace to rising borrowing costs. 

“That could be a real shock to the corporate debt system if rates stay this high through 2027 and through 2028 into the later half of this decade,” said Michael Zdinak, head of the US consumer markets service at S&P Global. (…)

“If profitability doesn’t grow with the borrowing costs, that’s where you’ll see a real credit issue,” said Moody’s chief credit officer Atsi Sheth. (FT)

Goldman Sachs:

Until recently, our financial conditions framework suggested that the drag from higher rates was roughly offset by higher equity prices, tighter credit spreads, and a weaker dollar. Adding up the effects on housing, consumption, and capex, we expect higher rates to subtract about 0.2pp from GDP growth in 2027, leaving the economy still growing close to our 2.3% potential growth estimate. If current rates persist instead, we estimate the drag would rise to slightly over 0.5pp.

We see two additional risks if current rates persist. First, higher rates could weigh on equity prices: our strategists expect equities to rise slightly over 10% by end-2027 but note that stable rates could limit upside. If equities were roughly flat through 2027 because of higher rates, the missing boost from wealth effects would lower consumer spending growth by just under 0.5pp.

Second, higher rates have revived fiscal sustainability concerns. The large primary deficit remains the main driver of the debt-to-GDP ratio, but persistently higher rates would boost interest expenses and push the ratio up faster—raising the odds that deficit reduction becomes necessary sooner to stabilize debt.

Meanwhile

Wall Street banks launch record $60bn chip deal for Broadcom and Anthropic

Wall Street banks on Monday began offloading part of a new $60bn debt package to fund Anthropic’s lease of Google semiconductors, the largest chip-financing deal to date as tech companies race to secure AI computing power.

Bank of America, Citigroup and Morgan Stanley, which have committed to fund the deal, have reached out to other banks to purchase portions of the debt, according to people familiar with the matter. 

The financing, guaranteed by Broadcom, is seen as a bellwether for appetite in AI debt. Investors in recent months have demanded a higher risk premium to lend to tech companies pouring trillions of dollars into developing sophisticated AI models, fuelled by concerns that their heavy capital investments might not translate into profitable businesses in the long run.

Much of the borrowing spree will fund the procurement of advanced chips that are getting more expensive by the day. The latest financing package follows Broadcom’s $35bn deal with Apollo and Blackstone just a few months ago, when the chipmaker announced a massive 20-gigawatt “AI XPV” platform to help the likes of Anthropic and OpenAI acquire computing capacity. (…)

With a lot more to come:

From Columbia University finance professor Stijn Van Nieuwerburgh. His paper was recently presented at the Brookings Institution.

(…) The resulting $10.3 trillion represents investment incurred during 2025–32, including pre-completion spending on projects that become operational after 2032. Assuming nominal GDP also grows by 4 percent annually, investment averages 3.63 percent of GDP over 2025–32. Table 1 places this estimate in historical perspective: it exceeds the corresponding investment shares associated with the canal, railroad, electrification, ighway, and telecommunications and fiber booms.

The scale of the AI infrastructure buildout raises a basic financing question: who supplies the capital and who ultimately owns the underlying assets?

(…) internal cash generation remains substantial, but it is no longer sufficient to finance the projected pace of investment without greater reliance on external capital or financing structures that shift assets and obligations away from the operating companies’ balance sheets. (…)

Debt financing has expanded alongside this third-party equity. Bank loans, comprised of mortgage loans backed by datacenter assets and syndicated lines of credit, remain important, but private credit and structured finance now provide a growing share of project funding, usually backed by long-term contracted revenues.

Financing is also extending beyond buildings and power infrastructure to the underlying IT equipment. GPUs and related hardware can be financed through leases or asset-backed structures, further broadening the pool of external capital available to AI firms and hyperscalers.

Yet this collateral differs from conventional real estate or aircraft: its economic life is shorter and rapid technological change creates substantial obsolescence risk, making its resale value less certain. (…)

The scale of external financing is already substantial. Morgan Stanley estimates that more than half of the roughly $2.9 trillion required to meet hyperscalers’ incremental compute needs over 2025–2028 will come from outside capital Across the full investment, it projects an approximate 60-40 split between equity and debt. Within the debt component, private credit accounts for the largest share—about $800 billion—followed by corporate debt of roughly $200 billion and structured finance of approximately $150 billion.

• “Spending by Alphabet, Amazon, Meta, Microsoft & Oracle is expected to jump from $412 billion in 2025 to $789 billion in 2026. That’s a 92% increase in just one year. By 2029, estimated capex from these 5 hyperscalers is nearly $1.2 trillion a year.” (@charliebilello)

The US Labor Market

September Hiring Trudged Along but Labor Market Still on Steady Track

US economy adds just 29,000 jobs in September as hiring slows sharply

The WSJ headline (top) sounds much better than the FT’s.

The WSJ:

The 29,000 number will seem low to anyone who remembers the job gains that routinely topped 200,000 in the years before the pandemic—much less the massive job gains that came when the economy reopened from Covid-19.

Jobs numbers for both July and August were revised down. Employers shed 10,000 jobs in July, down from a previous estimate of a gain of 21,000. August’s job gain was revised to 133,000, from 162,000. Combined, revisions trimmed 60,000 jobs from the previously estimated tally for July and August.

But the economy doesn’t need to generate as many jobs as it used to just to keep the labor market steady. The population is aging, and an immigration clampdown has reduced growth in the supply of workers.

In a positive sign, what is called the labor-force participation rate—the share of people working or looking for work—inched up slightly. “That all speaks to continued strength in the labor market,” said Kathy Bostjancic, chief economist at Nationwide. (…)

The most important development was that the report provided no signs that the labor market is tightening in ways that would add to price pressures. (…)

“There are clear signs of a positive spillover” from data-center spending into the job market, said Ruchir Sharma, U.S. economist at Nomura.

The FT:

The US economy added just 29,000 jobs in September as hiring slowed sharply from the previous month, raising doubts over the resilience of the labour market and the outlook for interest rate rises.

Friday’s figure from the Bureau of Labor Statistics marked an abrupt reversal from the downwardly revised 133,000 jobs added in August and was well short of the 88,000 job gains anticipated in a Bloomberg poll of economists.

Hiring decelerated across multiple sectors, with healthcare, a big driver of job gains in previous months, slowing sharply. Employment in the financial sector continued to contract.

Payrolls for July and August were revised lower by a combined 60,000 positions. The July figure fell to a loss of 10,000 jobs. The unemployment rate climbed to 4.2 per cent in September from 4.1 per cent in August.

Amid high monthly volatility, quarterly data provide clearer trends: growth in labor income keeps slowing, from 4.0-5.0% annualized in 2025 to 3.5-4.0% in 2026, with increased hours offsetting slower job growth and wage gains now rising at a 2.5% annualized rate, well below inflation, core or not.

Labor income YoY growth (black below) has been stable around 4.0% in 2026 but accelerating inflation is eroding purchasing power, offset by a big drop in the savings rate, lately sustaining nominal spending growth to 6.0%.

Boomers spending their savings plus the strong wealth effect add to the AI boom, keeping the US economy humming amid all the turmoil.

Vulnerabilities are developing however:

• it’s easier and faster for employers to cut hours than jobs if demand slows;
• the wealth effect is also carving its own K shape: investors with tech stocks are doing OK but those without are now suffering;
• at 2.5% annualized, wage growth is well below inflation, requiring that the 2 warnings above don’t materialize.

Saudi East-West Oil Pipeline Is Said to Be Flowing as Normal After accounting for supplies to refineries on Saudi Arabia’s west coast, Aramco had about 4.5 million barrels a day of flows available for exports as of last week

• Strike For Strike: Yemen’s Houthis Claim Attack On Saudi Aramco Facility In Retaliation To Sanaa Air Raids

Yemen’s Iran-aligned Houthi movement has claimed responsibility for a missile and drone attack on Saudi Arabia’s energy infrastructure, saying it targeted an Aramco facility in Riyadh in retaliation for Saudi-backed military operations in Yemen.

Houthi military spokesman Yahya Saree said the group launched long-range ballistic missiles and drones at the Saudi facility and described the operation as precise. He claimed the attack caused fires at the targeted site and warned that the Houthis would respond to any further escalation by Saudi forces. (…)

The Houthis said their latest attack was a direct response to Saudi military operations in Yemen, including airstrikes against Houthi-controlled areas. Saudi-backed forces supporting Yemen’s internationally recognised government have intensified military operations across several fronts, including areas around Taiz and Lahij.

Yemeni government forces reported 97 military operations targeting Houthi reinforcements around the Tor al-Baha front and Taiz axis. They claimed that the operations targeted about 260 Houthi fighters and destroyed or disabled 44 military vehicles. The figures could not be independently verified.

Meanwhile, Saudi-backed forces have continued airstrikes against Houthi strongholds in Sanaa, Saada and surrounding provinces. Health officials in Sanaa have reported dozens of casualties from recent attacks, while Houthi projectiles have contributed to heightened military tensions along Saudi Arabia’s southern border.

The latest escalation follows the collapse of a fragile truce established in 2022. Fighting has since intensified across multiple fronts, including Taiz, Lahij and Marib, with regional reports suggesting that Saudi Arabia and Yemeni government forces could be preparing a larger offensive to reverse recent Houthi gains. (…)

• Iran says Strait of Hormuz will not reopen until conditions are met

The Strait of ​Hormuz will not reopen until seven Iranian conditions set out in a June interim agreement with the US ‌are met, state media reported Iran’s parliament speaker Mohammad Baqer Qalibaf as saying on Sunday. (…)

“The position of the Islamic Republic of Iran is completely clear and firm, and ​the Strait of Hormuz will not be opened until our seven conditions, based on the Islamabad ⁠Memorandum of Understanding, are met,” Qalibaf, who is Iran’s top negotiator, was quoted as saying.

He said Washington “must understand that the period of ​dragging out the (diplomatic) process and dictating one-sided demands is over”.

“The Americans’ propositions are more or less in line with their previous positions, specifically on the nuclear issue. We told them our focus in this stage is the issue of the ​Strait of Hormuz and the return to security in this waterway requires clear steps from the US,” spokesperson Esmaeil Baghaei said.

He ​also denied Tehran had offered UN nuclear watchdog inspections of its nuclear facilities in exchange for US sanctions relief, saying Iran had not entered into ‌nuclear ⁠discussions with Washington.

The document being circulated outlines a seven-day period of trust-building aimed at returning the two sides to an enhanced version of the memorandum of understanding agreed in June, including concrete steps on Iran’s nuclear programme, an official briefed on the talks said last week.

The disagreement centres on the sequencing of the steps rather than the components of the plan, the official added. (…)

Bond Vigilantes Gone Wild (Ed Yardeni)

The Bond Vigilantes have gone wild worldwide, pushing government bond yields higher in developed and emerging markets alike.

A month ago, we asked whether rising yields reflected stronger growth, higher inflation, or looming fiscal crises. We still think the answer is mostly growth. The exception is where government finances are weakest. There, bond investors are charging a fiscal-risk premium. France may be on the verge of a full-blown debt crisis. (…)

Six of the 22 bond markets on our list have seen 10-year yields climb 100bps or more this year. France leads at 131bps, with the US second at 112bps. Italy, Indonesia, Japan, and South Korea round out the group. (…)

The Bond Market’s Tokyo Story

The Japanese budget deficit, central bank policy and currency are all playing an immediate role in the intensifying global bond selloff, leading to knockdown effects on American consumers who end up saddled with higher borrowing costs. (…)

In recent months, Takaichi’s government has made record spending requests, with a mind to boosting Japan’s slow (and slowing) economic growth. The concern is where all of that is going to come from. (…)

That means a few more shovels full will be added to Japan’s $9 trillion public debt pile, which at roughly twice the size of its economy makes it the most indebted advanced nation on earth.

To make matters more complicated, in an August interview with the Yomiuri newspaper, Takaichi said the government intends to cap the issuance of new government bonds at 40 trillion yen next year, or about $255 billion.

Unsurprisingly, the mix of increased spending, cuts to revenues and limiting debt financing has raised more eyebrows on the bond market than a silverback gorilla bathing in a hot spring reserved for Japanese macaques.

For Japan, this cloudy outlook has accelerated the rapid bond market sell-off that’s impacting economies around the world.

The bond market has effectively told governments in recent weeks: “If you want us to loan you money for a decade or 30 years while you’re spending more and more, you’re gonna need to pay us a higher premium for taking on the risk.” (…)

Adding to those pressures are circumstances out of Japan’s control. Central banks, including the Bank of Japan, have been pressed to hike interest rates because the U.S.-Iran war has raised the cost of energy and especially of diesel. (…)

Governor Kazuo Ueda told a press conference in Tokyo that the bank’s focus flipped from trying to raise the country’s persistently low inflation to its 2% target to trying to stabilize inflation against the upward pressures caused by the war, the massive global spending on AI and a weakened yen.

According to a summary of the BoJ’s meeting, most policymakers believe they should follow last month’s rate hike with more.

The American Angle

All of this activity in Japan, the world’s fourth largest economy and one of its most heavily financialized, impacts the U.S. bond market and, ultimately, American consumers.

The most straightforward impact is simple, upward pressure. The decades-high government yields in Japan, the U.K. and Europe are all driving each other higher, as investors try to lock in better returns, and U.S. bonds are no exception. (…)

The 10-year U.S. Treasury yield, a key benchmark for borrowing costs, rose to 5.34% on Thursday, the most since 2002. In the third quarter, it rose nearly 90 basis points, or the most in any quarter in over 25 years. (Japan’s 10-year government bond yield has risen by double digit basis points for five straight quarters).

The U.S. bond yield, of course, is also being driven up by inflationary pressure and increasing investor concerns about its own government spending and debt, which is nevertheless considerably smaller than Japan’s when measured as a percentage of GDP. The enormous volume of private sector spending on artificial intelligence is also exerting upward pressure on yields.

“As more and more of the AI CapEx is financed in debt markets, we are seeing there’s some competition now for government borrowing,” said George Cole, the head of European rates strategy at Goldman Sachs Research, on a podcast last month.

But there’s another reason for Japan’s outsized impact on the U.S. Treasury market: Japan is the largest foreign holder of U.S. debt. As of July, the country had roughly $1.1 trillion U.S. Treasuries, equal to 12% of all foreign held U.S. debt, as of July, according to Treasury Department data.

This was in large part a function of the country’s relatively low interest rates, which for decades depressed bond yields and incentivized investors to seek out better returns abroad.

The normalization of interest rates and rise of bond yields at home means Japanese investors have less reason to place their money abroad.

A TD Bank analysis earlier this year found these shifts mean Japan’s insurers and pension funds, which have been “a key source of stable, long-duration demand for U.S. Treasuries,” will likely keep their money at home, reducing Treasury demand and thus driving up borrowing costs for the U.S. government.

Another factor that weighs on Japanese investors is the yen, which has flirted with four-decade lows this year.

A weak yen makes life more expensive at home for the Japanese, forcing Tokyo to consider selling off its dollar assets including Treasurys, which would threaten the U.S. with even higher borrowing costs. It also makes it harder for U.S. companies to compete in Japan’s important retail market because imports are suddenly much more expensive.

This is why U.S. Treasury Secretary Scott Bessent has aggressively moved to boost the Japanese currency. “I am the house now, and you can bet against me if you want,” he declared last month, after U.S. and Japanese officials confirmed a joint intervention to support the yen worth of tens of billions of dollars.

Along with the BoJ’s latest rate hike, the intervention helped the yen add 3.3% against the dollar in the third quarter, making it the top performing currency in the G10 for the period, according to Deutsche Bank.

Other policy factors were likely under consideration.

“A weak yen tends to put pressure on other Asian currencies, and it could make it harder for China to continue to allow a slow appreciation of its currency,” wrote Brad W. Setser, a senior fellow at the Council on Foreign Relations, in August. (…)

On the other hand, Bessent and the BoJ have to be careful about balancing the currency’s strength with rate hikes in Japan. The suddenly surging yen has caused headaches for investors who use the so-called carry trade, a term for borrowing cheap Japanese currency to invest it in assets with higher yields. If the yen keeps rising and the BoJ proceeds with planned rate hikes, borrowing in yen will suddenly become more expensive.

Many market observers fear that could force investors to sell U.S. stocks and Treasuries to close out the trade. Some say it’s already happening.

“A more likely explanation for the global bond market rout [than inflation] is that the yen-carry trade is unwinding as the Bank of Japan raises its policy rate, forcing carry traders to sell government bonds they bought worldwide with proceeds from cheap yen loans,” wrote Yardeni Research President Ed Yardeni last week. “This trade allowed many governments to run budget deficits without putting upward pressure on their bond yields. Now, the chickens have come home to roost.”

In the immediate term, the rising bond yields in Japan, the U.S. and elsewhere are dictating the terms for borrowing costs across economies, which includes mortgages, auto loans and student debt. Borrowing becomes expensive for consumers and companies, not just governments.

Japan may be a long way away, but surging 30-year U.S. home loan rates have blown up the playbook for would-be borrowers, topping 7% while home prices remain at record highs. The rising sun is just over the horizon line.

Callum Thomas illustrates the impact higher rates are having:

• Equal-Weighted Weighed-Down: however, the equal-weighted S&P500 closed September down -5% m/m, and has seen an almost -7% drawdown off the mid-Aug peak. Breadth has also plunged to the worst levels since the 2025 tariff-tantrum. And there is a very clear reason for this…

Source: MarketCharts.com

• It’s a Rates Thing: rate-sensitive sectors have been clobbered —declining an average -10% thanks to the Fed pivot to rate hikes + global sovereign bond bust.

Source:  Can Anthropic Outearn Its Obligations?

• Rates Wreckage: here’s another angle on it, small caps have also come under significant pressure from rising bond yields particularly as a lot of small cap companies have poorer profitability, lower rated credits, and more floating rate debt. But the other usual suspects have also come under pressure as the hangover from the Iran war ripples across macro and markets.

Source:  The 5% Treasury Yield: It’s Here and How It’ll Affect Stocks

Source:  @SamRo via @TheShortBear

Bad, bad breath:

The McClellan Summation Index (red line, broadly whether the typical stock is doing relatively better or worse than the index).

Fear is winning over greed:

Opportunities?

• Real 10Y rates are near their 25-year peak:

• But, but, look at the pre-2000 years. Real yields were much higher:

• The term premium (extra yield investors demand to hold a longer-term bond instead of continually rolling over short-term bonds for the same period)

• The term premium vs core inflation:

It seems like a “In Warsh We Trust” decision.

US Lead in AI Over China Narrows After DeepSeek Gains, BI Says

American AI companies’ performance lead over China narrowed sharply in past months to a record low after labs such as DeepSeek gained ground, threatening US tech supremacy, according to Bloomberg Intelligence.

Top Chinese models lag their US rivals by just 3% on benchmark scores after the September release of DeepSeek’s V4.1 Flash, BI senior analyst Robert Lea wrote in a report Monday. That’s down from about 9% in May and 15% earlier in the year. That improving performance spells further market share gains for Chinese contenders, he said.

China’s ascent is a result of deepening AI expertise and its researchers’ ability to optimize their models for domestic hardware. The gains raise questions about the usefulness of US export restrictions on technology such as Nvidia Corp. chips, intended to curtail Chinese AI advances and prevent the likes of Huawei Technologies Co. from making progress with their own alternatives.

The Asian country’s progress “casts further doubt on the long-term sustainability of US technological supremacy in AI,” Lea said. (…)

DeepSeek’s V4.1 Flash ranked sixth globally last month on LiveBench, making it the highest-ranked Chinese model since the startup broke ground with its reasoning model R1 in 2025. LiveBench scores AI models based on their responses to and analysis of questions, puzzles or tasks, a process akin to gauging human IQ.

DeepSeek last recorded a LiveBench score of 81.1, below Anthropic’s best score of 83.4. That means the DeepSeek model delivers “comparable performance” to leading AI systems from Anthropic and OpenAI, Lea said. Still, while the score gap has narrowed to just 3%, just three of the top 15 models as assessed by LiveBench were Chinese. (…)

The Chinese AI industry could remain unprofitable until 2030, Lea said. A focus on low-margin token supply and a brutal price war may make it impossible for any firm to gain a competitive edge in a domestic market flooded with more than 1,100 large language models.

ByteDance Ltd.’s Doubao is the frontrunner in AI app monetization, while the chatbots of rivals DeepSeek and Tencent Holdings Ltd. remain free, Lea said.

“Putting China’s AI sector on a sustainable profit footing will require a cooling of competitive pressures, an industry shakeout, and a more rational approach to pricing,” he said.