A layman’s guide to CrossBorder Capital’s latest financial outlook.

The core problem: A tsunami of government debt

Macroeconomic research house CrossBorder Capital’s Michael Howell recently summarised the dilemma confronting the U.S. Federal Reserve under newly appointed Chair Kevin Warsh.

For most, the use of proprietary indicators and the esoteric interpretations is likely to be skimmed over, but sometimes a bit of additional attention pays dividends. Right now might be one of those junctures.

The U.S. government funds its budget shortfalls by issuing bonds – essentially IOUs to investors. To keep this system running smoothly, two things are required: balance-sheet capacity (the financial ability of large institutions to buy and hold these bonds) and market liquidity (the amount of readily available cash circulating to trade them).

Right now, both are shrinking just as the government’s borrowing needs are exploding. In 2026, the U.S. Treasury is on track to auction off roughly US$25 trillion in gross debt (including issuing new debt and rolling over maturing debt). That amounts to US$500 billion in bonds hitting the market every single week.

The Central Bank’s trap

This creates a dangerous mismatch: there is too much debt trying to find too little cash, leaving central banks, like the U.S. Federal Reserve, in a difficult position:

• If they inject more cash into the system to help buy the debt, they risk triggering high inflation and inflating “asset bubbles” (making stocks and real estate unsustainably expensive).
• If they raise interest rates to combat inflation, it costs the government much more to pay interest on its debt, widening the deficit and threatening a full-blown financial crisis.

Historically, when a market shifts from having abundant cash to being overwhelmed by debt, it triggers a transition from what Howell refers to as an “everything bubble”, which we experienced between 2015 and 2020, to an “everything bust.”

The yield curve is flashing red

Normally, long-term bonds pay higher interest rates (yields) than short-term bonds because investors demand a premium for locking away their money for longer. This extra reward is called the term premium.

Recently, the market has experienced a “bearish flattening” of the yield curve. This means that while all interest rates are rising, short-term rates are rising faster than long-term rates. This occurs despite the fact that the government has pumped over US$600 billion of extra cash into the system since late October 2025 to try to calm things down. In the financial world, a bearish flattening is a classic late-cycle warning sign that a severe cash shortage is brewing.

Why interest rates might rise further

According to Howell, long-term interest rates are fundamentally anchored by Nominal Gross Domestic Product (GDP) growth (how fast the economy is growing, including inflation).

• The U.S. economy is currently expanding at a nominal pace of about 7 per cent.
• However, the benchmark 10-year U.S. Treasury bond is currently paying a yield of only about 4.5 per cent.

This 4.5 per cent rate is artificially low. The U.S. Treasury achieved this by intentionally flooding the market with short-term bills while holding back on issuing long-term bonds, creating an artificial scarcity of long-term debt. However, because the sheer volume of total debt is so massive, this strategy is losing its effectiveness. Howell posits that a 10-year bond yield closer to six per cent is far more realistic based on actual economic growth.

If long bond rates hit six per cent, you can probably say goodbye to the artificial intelligence (AI) bubble in the stock market.

What this means for investors

As U.S. economic growth remains hot, government interventions fade, and cash reserves shrink, Howell expects U.S. Treasury yields to head towards the 5.5 per cent–6.0 per cent range.

While this may not completely break the economy, it has major implications for your portfolio:

• Capped returns: Higher guaranteed returns on government bonds mean investors will demand lower prices for riskier assets, such as stocks. If Howell is right, this places a firm ceiling on stock market gains from here.
• More rate hikes: The bond market is already pricing in two additional 0.25 per cent interest rate hikes by the Federal Reserve over the next 12 months. Some analysts are pointing out the equity market has taken those expectations in its stride. Others suggest the market’s reaction isn’t concluded.
• Watch the warning signs: The gap is widening between the 2-year government bond yield and Secured Overnight Financing Rate (SOFR) (the interest rate banks charge each other for overnight loans backed by Treasuries). Historically, when this gap widens, a severe market cash shortage follows within six months.

New Federal Reserve Chair Kevin Warsh may have to raise interest rates aggressively early on to keep the bond market from spiralling out of control. That would mean investors should brace for higher interest rates and more volatile markets.