U.S. Treasury yield spillover puts junk bonds and U.K. public finances under pressure

Debt-market pressure begins to spill over

Long-term U.S. Treasury yields have been high over the past few days: the 10-year yield is about 5.27%, the 30-year about 5.46%. What’s new today is that this pressure has begun to transmit to corporations and to other countries.

Start with corporations. A report on Wednesday pointed out that the sharp sell-off in U.S. Treasuries is transmitting to lower-rated "junk" companies, forcing them to readjust their borrowing plans. Junk bonds refer to corporate debt with relatively low credit ratings and higher default risk; borrowing costs more for them. When Treasury yields rise, that lifts their overall financing costs. Data cited by the model also show that the high-yield credit spread is 3.03%, having widened 36 basis points, about 0.36 percentage points, over the past 20 trading days. The credit spread is the extra interest junk bonds pay over Treasuries; a widening spread indicates the market is less confident about these companies.

Next, look at the U.K. On the same day, U.K. government borrowing rates rose to their highest level in 28 years, and officially disclosed public finance borrowing exceeded expectations. Taken together: when the government borrows more, there are more U.K. government bonds in the market, buyers demand higher returns to take them on, and rates are pushed up. Higher rates increase the government's future interest burden and tighten public finances, creating a cycle that is hard to stop. With euro-area inflation at 3.8% in September and the policy dilemma from tighter finances, the U.K. news adds another example.

Then China’s numbers. The State Administration of Foreign Exchange on Wednesday announced that, as of the end of September, foreign exchange reserves were 34003 hundred million USD, down 381 hundred million USD from the end of August, a decline of 1.11%, but they have remained above 3.4 trillion USD for six consecutive months. The report mentioned that since September the Federal Reserve launched its first rate hike of the year, making dollar assets more attractive and shifting global capital allocations. Many assets in the foreign exchange reserves are non-dollar; when converted into dollars their value falls, and weak international capital markets also weighed on the nominal size. Researcher Pang Ming told a Securities Times reporter along these lines. This shrinkage mainly came from exchange-rate translation and asset price moves, and does not mean someone conducted large-scale sales.

There is also new commentary on energy. Russell Hardy, CEO of commodity trader Vitol, said Western countries have already exhausted the oil inventories available to offset supply disruptions, and energy tightness from a U.S.-Iran war is spreading to global shipping. To use an analogy, inventories are like a household’s emergency food supply: once the stock is gone, a new supply cut will directly push up prices. Rising oil would further add to inflation expectations, which is bad news for an already high-rate environment.

There is a countercurrent. Equities have not fallen in sync: QQQ is still up 5.78% over the past month, and on Wednesday SPY only fell 0.24%. Stocks’ reaction to the bond-market pressure has so far been much milder than that of the credit market and U.K. government bonds.

Other things worth knowing

China’s insurance industry has seen concentrated capital increases in the past month. Guobao Life plans to increase its total shares from 1,980,000,000 to 4,521,000,000, at RMB 1.21 per share, raising registered capital by about RMB 2,541,000,000. China Merchants Renhe Life plans to issue about 1,857,000,000 new shares to raise about RMB 2,656,000,000. Capital is the buffer for insurers: the thicker the cushion, the more room to handle investment volatility and claims pressure. Both companies disclosed plans on the eve of the National Day holiday, indicating that the industry’s need to replenish capital is becoming concentrated.

In real estate, the Greater Toronto Area’s home prices fell in September to a 6-year low, down 28% from the peak. Sales have retreated and inventories are at historic highs. Across the ocean in the United States, property tax delinquencies have risen to the highest since 2017. High rates’ pressure on real estate and household debt-servicing ability is showing up in both countries.

Today’s logic: government bond yields are the floor of borrowing costs

When corporations and governments borrow, the rate is roughly "Treasury yield plus a markup." Treasury yields are like wholesale prices; corporate borrowing is like retail: when the wholesale price rises, the retail price is unlikely not to follow, and the worse the credit, the bigger the markup. So when Treasury yields rise, high-quality firms see their interest costs rise by a chunk, while junk issuers face both higher wholesale prices and thicker markups and are squeezed on both ends.

Today’s examples illustrate this: after the Treasury sell-off, junk issuers started to adjust borrowing plans; U.K. government borrowing rates rose to a 28-year high, showing that even the most stable borrower has to borrow at higher costs. When that floor moves, prices along the entire borrowing chain are re-priced.

What the ETF Radar model says

First EWU, the U.K. equity ETF. It actually fell 1.29% over the past 5 trading days (about a week) and is down 3.97% over the past month. This has a direct transmission relationship with today’s U.K. news: fiscal borrowing exceeded expectations, Treasury supply increased, yields rose, and equity valuations were pressured. Evidence cited by the model is: the high-yield credit spread is 3.03%, having widened 36 basis points over the past 20 days; the number of shares of EWU sold short increased 6.1% from the previous period, indicating some money is betting on its decline. There are also uncertainties: net subscriptions over the past 30 days were 1.81%, the Fed’s net liquidity is about 5,792B USD, having increased by 23.0B USD over 4 weeks, and the VIX term structure is calm — all of which constrain extreme downside. Looking ahead, the ETF Radar model’s directional view for the next 1-3 months is mildly negative. EWU’s recent moves align with this; this view shifted from neutral to negative today.

Next KRE, the regional bank ETF. It actually fell 0.52% over the past 5 trading days (about a week) and is down 7.06% over the past month. The transmission chain is: rising rates and wider credit spreads put pressure on regional banks’ asset quality and consumers’ repayment ability, potentially increasing delinquencies and charge-offs. There are two pieces of evidence. One is U.S. nonfarm payrolls in September increased by 29,000, far below the expected 89,000; slowing employment will weaken household repayment capacity. Two is net real flows over the past 5 days show net outflows equal to 1.41% of assets, indicating capital is exiting. U.S. property tax delinquencies rising to the highest since 2017 also resonates with this chain. Uncertainties include the Fed’s net liquidity of about 5,793B USD, which offers short-term buffer, and the number of days to cover for shares sold short is 4.67 days, so there could be passive short-covering around earnings windows. As for the outlook, the model’s directional view for KRE over the next 1-3 months is mildly negative.

Finally QQQ. It actually rose 2.43% over the past 5 trading days (about a week) and is up 5.78% over the past month. The model’s directional view for the next 1-3 months is mildly negative, which contrasts with recent performance; this simply means the model is looking at the next one to three months, and recent gains have not yet been reflected. This view is not directly related to today’s U.K. and junk-bond headlines but is the model’s independent medium-term judgment, coming from the European Central Bank’s rate cycle. Evidence: euro-area inflation was 3.8% in September, above the expected 3.7%; prediction market Polymarket gives the probability that the ECB will hold rates in October as 0.89, indicating the market is not pricing in an easing shift; CFTC data show Nasdaq futures speculative net positions are net short 24,723 contracts, i.e., more contracts are betting on declines than on rises. Net real flows over the past 5 days were net outflows equal to 0.67% of assets. Note that if Polymarket’s probability quickly falls below 0.6, or if CFTC positions flip to net long within two weeks, this view should be reassessed.

Closing

The new development today is that pressure from long-term yields has spread from the bond market itself to junk issuers, U.K. public finances and the book value of China’s FX reserves, while equities have so far reacted mildly. A reminder: the above are system quantitative model directional forecasts for general markets and do not constitute personal investment advice; consult a licensed investment advisor before investing.