If the higher interest rates are causing such pain in both the financial markets and the real economy then it would seem important to understand why they are rising.

The strong US economy - best symbolized by the jobs report we have already discussed - is one reason but it isn't the only one.

In short, there are 5 other significant reasons this is happening:

• US Debt, as you may recall, has been downgraded.

• The Federal Reserve is not just raising interest rates, it is also unwinding its previous asset purchases on its balance sheet.

• The US is running a massive budget deficit.

• Japan, one of the largest foreign holders of US debt, has changed its monetary policy and its own debt is proving attractive to hold for the first time in a long time.

• China is doing likewise though for murkier and less understandable reasons.

We don't want to get too deep in the weeds on these points but we do think a brief discussion of each one is important.

First off, US debt was downgraded in early August. We wrote about it then and you can read about it here.

In short we concluded:

"...the US' fiscal and long term debt trajectory has changed quite a bit and in nearly every case, it has changed for the worse.

......

What will happen to that as well as our debt-to-GDP and debt servicing costs when the recession comes?"

So, following on from that, one of the reasons bonds are selling off so much is people are concerned about the fundamentals of the US's long term trajectory as a debtor. Our entitlement spending, in particular, looks out of control.

We don't think this is a primary reason - markets tend to struggle with even critical issues until they are staring them in the face - but it would seem pretty remiss not to mention what a serious signal about the economic health of the country this was.

There is also the fact that now the lone remaining credit rating agency, Moody's, could downgrade the US at any time. It wouldn't be like they don't have cause. After all, they are now the outliers....

Second the Federal Reserve is shrinking its balance sheet at the moment. That means it is letting some portion of the bonds it bought during periods of quantitative easing roll off.

This is the inverse of quantitative easing and unsurprisingly is called: quantitative tightening.​

This may seem minor but it means that when NEW US debt is issued by the Treasury Department, a very large buyer - the US central bank itself - is no longer buying some of the stock of that newly issued debt which means there is a less competitive market for those bonds.

Hence, lower bond prices, higher bond yields.

Third, the US is simply running a massive budget deficit at the moment.

​This deficit has been constantly upgraded by the non partisan Congressional Budget Office we always reference and now stands at some $1.7 trillion for the fiscal year.

This is shockingly bad.

The reasons it is problematic are twofold:

• It is high (and growing!) on a historical basis.

• And it is also happening while the economy is growing strongly, not shrinking.

This is doubly unusual. Typically deficits are very small during the good part of the economic cycle and blow out during recessions. It is a symptom of how out of control our spending is - a long running Pebble theme - that our deficit is soaring during the good times.

One of the things to be aware of is that this "high deficits in good times and bad" reality is a bad sign and also a new one. The situation isn't just negative, it is deteriorating.

In conclusion, despite some of the irresponsible talk on the right and especially the left in this country: yes, deficits do actually matter.

For one thing, it means that if and when we actually have to cut interest rates they might not act as we suspect and need. Our debt may prove less attractive than we would like.

Fourth, Japan has changed its monetary policy and made it less attractive for its domestic savers to buy US debt.

This is a bit esoteric but bear with us. The essential point is that after years of formally controlling the yields of its sovereign debt, Japan's central bank has now changed policy and let those yields rise.

This had to happen because - surprise, surprise - after years of suffering deflation Japan is now experiencing mild inflation. This made their bonds incredibly unattractive to hold at the earlier manipulated levels.

Why buy something that is artificially suppressed by your government AND is likely to lose rather than gain value?

Now Japanese government bonds are slightly attractive and this has meant that large Japanese institutional like life insurance companies and insurance funds are much less attracted to US bonds to get the yields they require. They can just buy domestic debt instead.

Fifth and final, China has significantly reduced its previously record holdings of US Treasuries.

This isn't new, to be fair. Since 2021 China has sold over $300 billion of US bonds. Its holdings now stand at around $822 billion.

However, as this graph demonstrates, the pace of selling has increased this year.

It is quite a bit more complicated than China simply "dumping" US debt. In fact they are currently buying other types of debt including various US bonds but the Middle Kingdom's ongoing economic malaise and weak growth and exports mean that they have fewer dollars to recycle into any form of US issued dollar-based security.

Previously, China exported goods globally in return for US Dollars and then turned around and bought US Treasury bonds with those dollars to keep their currency from appreciating and making those same exports less attractive.

This was, to simplify extremely, China's economic strategy for nearly 40 years as it re-opened to the world.

Now they are doing less exporting and are also less politically interested in owning US debt for strategic and self preservation reasons.

So, let us summarize:

In the US the long term debt trajectory is very poor, short term spending is very high and atypically so for the point in the economic cycle we are at; furthermore, foreigners - friendly and not - are no longer buying our bonds at the pace they once did and our central bank is also no longer a big buyer in the marketplace.

So, many of the ingredients that kept US debt cheap and manageable for the last few decades are gone. They may not be returning any time sooner either.

That is super important to remember when you pine for cheaper mortgages or easier credit conditions. Wishing for something won't make it any more likely to happen.

If you squint, we are doing okay for now. The economy is still growing and we can afford our debt payments and interest rates. The question is obviously: what happens next?

There is a lot of uncertainty but the truly worrying scenario might really be: what if growth falls but inflation and interest rates rise?

We have experienced that before but the difference is our debt dynamics - as a country and also as companies and individual borrowers - is far worse.

As consumers, as companies, as a country, as a whole society, we have gorged on debt for a long time.

Now we need a way out. For a discussion on the possible paths you will need to wait for a later edition of this newsletter.

For the present, to borrow a metaphor from an infamous movie on finance, though the music on US debt has only begun to slow, it hasn't yet actually stopped. We better hope that it doesn't any time soon as the legendary Jeremy Irons reminds us:

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