The Shock Heard ‘Round the World: US Government Bonds

Hello, this is Dean Kurnut and welcome to the Alpha Exchange, where we explore topics

in financial markets associated with managing risk, generating return, and the deployment

of capital and the alternative investment industry.

Economic, monetary, financial, and geopolitical.

These are my four horsemen of risk, a descriptive shorthand for categorizing sources of uncertainty.

They are unique, but they overlap, and they interact.

And in today's climate, this interaction is intense.

What follows is a discussion about market prices set against the uniquely uncertain times

in which we live.

Specifically, I wish to share with you a view of developed over the past few years, and

that is, unfortunately, that the US is a chief component of the risks that could be disruptive

to the market.

I'll bring in four recent Alpha Exchange discussions with expert guests to do so.

My hope is that this will contribute to your thought process on risk.

As my main man, Logan Roy would say, let's get into it.

As I write this, we face one of the most daunting backdrops for appreciating the set of uncertainties

in front of us.

The pace of change in technology and in geopolitics is unimaginably rapid.

In the meantime, the architecture of the financial system is being redesigned.

And also, in the meantime, the US fiscal condition only deteriorates.

Let's start with technological advancements which are coming at breakneck speed.

The promises and the potentially positive outcomes are incredible.

The threats, however, are daunting.

AI is forcing a wholesale re-underwriting of assumptions about the value of knowledge

work.

And in the process about future cash flows and annual recurring revenue, about industries

like insurance, wealth management, logistics, cybersecurity, and, of course, software.

A sub-stack memo written about a future that looks back on the past, catalyzes a giant

sell-off in sectors deemed exposed.

There's no earnings announcement or unwelcome economic statistic the market is confronted

with.

It is the thought experiment alone that is the risk off.

It leads to downside vol in the very way that a thought experiment a year earlier led to

upside vol.

Then it was endless possibilities.

Now skies the limit became the sky is falling.

What should we take away from the impact of the Satrini memo?

First I believe it's framing was highly effective.

The piece zooms forward but looks back.

We are in 2028 and I am showing you news stories that occurred a year earlier.

There's something about reading a headline from a press story you are told has already

happened.

That feels definitive.

It's a statement of fact, a review of the past, about something that hasn't even happened

yet.

Second, sub-stack and Twitter.

The memo has 16 million views and counting on Twitter.

On its best day, the Goldman Tech research team couldn't dream of such exposure.

The speed with which information gets shared is new and powerful.

We live in an era of attention capitalism.

Remember the Nick Shirley video on the Learing Center fraud in Minnesota?

That got, wait for it, 135 million views on Twitter.

It went live on December 26th of last year.

Tim Walls withdrew his bid for re-election for governor 10 days later.

Action, reaction.

And here we thought it was going to be Sean Hannity that took down Walls.

Our second takeaway from Satrini is that market prices are always built on assumptions

and sometimes those assumptions become fragile.

What makes them sell?

Price does.

When we pull forward a future based on especially optimistic assumptions, we embed them in price.

I've often said that market-vol events are the result of a confrontation between the

existing and a new set of assumptions.

Markets are incredible mechanisms for allocating capital, but of course they are wrong on a regular

basis.

Sometimes these errors are small.

A mistaken assumption on non-farm payrolls or inflation.

Occasionally, however, the market gets it very, very wrong.

As a view is underpinned by a stronger consensus, it becomes baked into market prices.

It means that when the consensus is shattered, the repricing can be violent.

Two decades ago, as the real estate markets sizzled and all kinds of derivatives were built

around the notion that housing prices could not decline on a national basis, the price

of credit risk for mortgages melted away.

There's a scene in the big short book in which, in late 2006, a trader at Deutsche Bank

working for Greg Lippmann is buying protection on a super senior tranche of subprime CDS from

a counterpart and Morgan Stanley.

As the trader forks over 28 basis points to get $2 billion of short exposure, he says,

we both know there's no risk in these things.

Of course, nothing could have been further from the truth.

The point is that the more convinced we are of something, the lower the probability we

assign to that not potentially being the case.

The Satrini memo succeeded in having the market reprice a tail outcome.

Of course, as death of knowledge work deflationary outcomes are contemplated, the existing set

of exposures underwritten on assumptions now tested becomes stressed.

Blue Owl is largely the poster child for publicly traded vehicles engaged in private

lending.

The stock's two month realized volatility has doubled from 30 to 60 since last September.

There's furious trading in the shares.

Option volume almost nonexistent last year is up, averaging almost 100,000 contracts

a day.

As we watch the AI displacement theme play out, we must recognize that a financial risk

off, one that is sponsored by wrong way exposures is a possibility.

Real liquidity breeds ill liquidity and we are seeing various episodes of gating.

Cliffwater, Morgan Stanley, BlackRock and Blackstone are among those that have announced

that they are limiting redemptions because they cannot satisfy them.

I can't help but think of that scene in Casino when Nikki Centoro tells his hapless banker,

Frank, I think I want my money back.

Not being able to turn your exposure into cash in a moment or in this case, even a quarter's

notice is a problem.

If there's one lesson, I believe investors consistently fail to learn it's the value

of liquidity.

We under price liquidity risk.

It's fine to bear liquidity risk, but in hindsight amidst a shortage of it, we almost

never believe we were properly compensated for doing so.

I'm old enough to remember 1998 in the LTCM debacle.

It was a superb example of when the risk of a portfolio really found its way into the

market's crosshairs.

It was a preview of the big one that would occur a decade later.

Of course, nothing was more protracted than the GFC when the entire system was upside

down.

There's a lot of discussion of whether today's circumstance is similar.

The answer is yes, in the sense that more people want their money back than can be satisfied.

Let's hope those redemption lines don't resemble those at the Houston or Atlanta airport.

Yes, there's a liquidity mismatch, which is similar to the GFC.

Bloomberg reports that quote, a wave of redemption requests across the private credit industry

has left more than 4.6 billion of investor capital trapped behind withdrawal limits with

more asset managers expected to impose curbs in the coming weeks.

Investors have looked to pull roughly 13 billion from over a dozen funds so far this

quarter.

The important caveat when looking at today's risk dynamic and comparing it to seismic

events like the GFC is around the degree of leverage in the system.

There's far less of a day.

In 2008, the XLF was realizing 100 vol for stretches of time.

It's realizing below 20 now.

When it comes to systemic financial risk, we ought not to ever shut the door on the possibilities.

But the core of the system is not currently showing any real stress relative to that

suffered in prior events.

So let's take stock of where we are.

We have a groundbreaking technology called AI.

It's single handedly created a massive capex cycle and been responsible for trillions

of dollars of additional market cap assigned to make a cap tech stocks.

Google alone added $1.5 trillion in market cap in 2025.

The S&P rose by 86% in annualized return of 23% from 2023 to 2025.

And because there's two sides to AI, the promise of productivity, but also the displacement

of it, the market recently went from the sky is the limit to the sky is falling in its

what if exercises from industry to industry, software, logistics, insurance, recruiting,

real estate brokerage, we've seen significant sell-offs.

And as investors reprise securities, it could be the case that certain vehicles, like

private credit, are viewed as increasingly vulnerable and find themselves unable to

meet redemptions.

Now let's introduce the second main catalyst for risk, the war, or should I say, engagement

in Iran.

Around the world and across the asset classes, it's hard to find a risk premium that isn't

considerably higher now than it was on February 26th.

The VIX, the move, credit spreads, credit vol, break evens, FX vol, look further and more

nuanced measures like vol skew and implied correlation are steeper and higher.

In Europe, there's been a spike in realized correlation among stocks.

In the Euro stocks 50, it's more than 50% over the last month, as the repricing of the

ECB's rate path has been dramatic.

These risks are priced into the US and other major developed markets, but EM volatility

has also surged.

The EEM VIX started the year at 17 and was recently north of 35, EM credit spreads are

similarly wider.

Those are all financially centric risk measures.

In market risk, a rising tide lifts all vols, but it's not all that applicable to soft

commodities.

So now, Claude tells me that roughly one third of globally traded fertilizer transits

the straight, an index of one month implied vol on corn, wheat, sugar and soybeans currently

maps well against the VIX.

The correlation of these two over the past month recently registered 72%.

If there's one thing we've learned about vol events over the years, it's that a supply

shortage and resulting in balance of supply and demand is at the heart of nasty price

moves.

LTCM in 1998, Volkswagen in 2008, the 2010 blow up in long dated equity variance, the

2011 surge in the yen after the nuclear disaster, the VIX implosion, the GME event in 2021,

the surge in nickel prices in 2022, nothing leads to vol more than a material imbalance

of supply and demand.

Supply shortages resolve through the demand destruction that results from much higher

prices.

It's easy to write, but it's a process that imposes incredible risk on the global system

of asset prices.

Move fast and things break, I say.

In the same way that higher prices are the cure for higher prices, higher rates can actually

be the cure for higher rates.

At some point, if the market sees a material economic slowdown as likely, the U.S. bond

market sell-off could conceivably reverse as the stag part of stagflation is prioritized

by policymakers over the inflation side.

This could clearly be wrong, and the reason is that the U.S. long viewed as a stabilizing

force in the world is now becoming a chief source of risk.

In the process, the Treasury bond market may be losing one of its most important characteristics,

the insurance feature.

That is, its capacity to be durable to and even benefit from market shocks.

We've all got to be asking, how can U.S. government bonds be a shock absorber when the

U.S. government is the source of the shock?

Now strange things do happen.

For example, who could forget the epic bond market rally in August of 2011 as a stand

off between Obama and the Republicans took us to the brink of a debt-sealing-induced

default.

About to default, let's make the market rally.

The 10-year effectively rallied from 3% to 2% in August 11.

These things are sometimes difficult to understand.

It was the case then that U.S. debt was $15 trillion, it's now $39 trillion.

This cost per year have increased along the way by $770 billion per year.

Debt to GDP is risen from 97% to 122%.

Those numbers are daunting to be sure, but it is the reason we got here that matters and

this is where I want to go next.

Our politics are poisoned.

We've lost the capacity to compromise.

There was a time when investors thought of the United States as the place where political

risk went to die.

Political ranker in Washington is certainly not new.

Elections have been ugly in the past and the two parties could fight, but beneath it

all sat a deeper assumption.

The institutions were strong and the rules would hold, and this would lead the country's

political machinery however messy to continue to operate with continuity.

It's impossible not to see that this is now breaking down.

One of the most important shifts in the global macro landscape is that the United States

is no longer simply the absorber of political risk from abroad.

Increasingly, it is a producer of it.

Avoid Trump-terangement syndrome and Trump-apologist disorder equally.

Just notice things and then ask yourself, what are the market implications?

As I've been thinking a great deal about this question, I began engaging with experts

on geopolitical risk and hosting them for conversations on the outfits change.

Traditionally, the term geopolitical risk conjures up conflict with other countries like

Russia, China, and Iran.

But it needs to include not just our strategic rivalries around the world, but internalized

strife at home and its global implications.

Here's what Alex Kazan, head of the geopolitical practice at the Brunswick group, had to say.

The US is now the world's major source of geopolitical risk and uncertainty.

That's a big, big deal, right?

It may sound sort of obvious thinking about that right now, given all the policy volatility

that we've seen around Washington, but it's actually pretty spectacular in terms of

a macro development.

I've been doing geopolitical risk analysis for most of my career, 25 years or so, and what

I work on has evolved a lot.

And that matters because of the vulnerabilities this imposes on one of our most prized assets,

the government bond market, which has long been priced as the global risk-free benchmark.

This market has historically been a destination for capital seeking safety.

It has exhibited an insurance quality, rallying in times of uncertainty.

I've walked through this a great deal over the years, tracking the negative correlation

between stock and bond prices quite closely.

Others would Ken Rogoff had to say about this.

You flock to the United States because the dollar is stable, because the economy is stable,

because policy is stable.

And to the extent we become more unpredictable, to the extent our court system is replaced

by the whims of an executive, not necessarily Donald Trump, it could be some later president.

It's less reliable, it's less safe.

With respect to the consistency with which the bond market rallies on a risk off, it simply

doesn't work that way anymore, at least not on a reliable basis.

Remember the tariff tantrum last year, the S&P experienced a large drawdown, the VIX spiked

to the 50s, and the treasury market actually sold off in the process.

And this year, the TLT is down almost 5% since February 26, two days before the US and

Israel attacked Iran.

About the 2025 tariff event, Libby Cantrill, head of public policy, had this to share on

a recent podcast conversation.

We also saw dollar weakness, currency weakness, rates backing up, plus risk assets on

off.

That's a characteristic of an emerging market country, not the US historically.

And so I do think that was a bit eye opening, just the behavior during that period of time.

You saw a little bit of that actually during this Greenland bout as well, obviously very

very short lives.

But I think it is a good reminder that sterling was a reserve currency until it wasn't.

These relationships exist until they don't, you can't take them for granted.

I'll just repeat what Libby said, these relationships exist until they don't.

Ken Rogoff added this, people all too often think if you look at 10 years, 20 years, 30

years, you just know everything.

And forget these tale events, China would grow to the moon forever.

Real interest rates would be zero forever.

And also that the dollar's dominance, which had been rising steadily, is something you

could just count on.

The US and by extension, US markets have served as the anchor of the postwar alliance system.

And the jurisdiction where institutional credibility was deepest.

It's been earned over many years of durable global leadership.

It can be unearned as well.

Mark Rosenberg, founder of GeoQuant, affirmed that model's geopolitical risk said this.

The United States, again, has a particular vulnerable set of political institutions.

There is another developed market that has something like the Electoral College, the Senate

that is constructed to over-represent rural areas.

And so what we have also is a particular set of institutions.

That social risk starts ramping up and then the institutional risk is vulnerable to ramping

up as well.

When confidence in those foundations begins to erode even gradually, the consequences

did not stay confined to politics.

They can spill into market prices like rates and FX.

They can impact global capital flows and into the premium investors demand to hold long

duration US financial assets.

The first issue imposing risk on our institutional framework is polarization.

Political disagreement in America is as old as Bernie Sanders.

But what has changed is its intensity and its character.

It's no longer simply a contest over tax rates, spending priorities, or who champions

big business versus the little guy.

Politics has become fused with identity, culture, geography, and media consumption.

The opposing party is not just viewed as wrong, but increasingly as dangerous, illegitimate,

or even, un-American.

That kind of negative partisanship changes the way a system functions.

It makes compromise more costly, trust more fragile, and procedural conflict more likely.

And when polarization deepens, the risks are not limited to rhetoric.

Investors need to think about process risk.

And this is what has me most concerned.

It's so generally comfortable pricing outcomes.

That's the business.

They can price a tax hike, a tariff, a change in regulation.

Even a war if they can map the channels.

What markets struggle with is uncertainty around the process itself.

Disputed election mechanics, contested certifications, legal escalation, executive legislation, confrontation,

or battles over who has the authority to decide and enforce political outcomes.

The under-appreciating risk in the U.S. today is that process instability is becoming

more central.

I think a logical question to ask is, how did we get here?

Many blame Trump.

He's an easy target.

Alex Kazan suggests otherwise.

I want to be very emphatic about this point.

It's not primarily about Donald Trump.

It really isn't.

These things are structural.

And we've seen signs of them emerge in the U.S. for the past 10 years or so.

One of that is the deep, deep partisanship in the U.S., which makes it much, much harder

for the U.S. political system to align around and have consensus around major foreign and

economic policies.

It's certainly not difficult to link the increasing loss of faith in the U.S. political

system with the global financial crisis.

Alex adds this.

The response from political economic business elites to these massive, massive crises

were self-serving, did not represent the interests of the average American.

And at the end of the day, as we came through those crises, the people who many Americans

view as responsible or partially responsible paid no price.

And ultimately, the narrative matters than the specifics of the facts.

The numbers are not subtle.

Pew found that only 4% of Americans say the U.S. political system is working very well

or extremely well.

While 72% say it is working not too well or not well at all, a full 63% say they have little

or no confidence in the future of the political system.

More than 8 in 10 Americans say elected officials don't care what people like them think.

And trust in Washington remains near historic lows.

Pew reported 17% of Americans in late 2025 say they trust the federal government to do

what is right always or most of the time.

These are alarming statistics.

Let's build on this with some of the analysis done by Mark Rosenberg.

His work, which did an excellent job of assessing the 2016 election where the mainstream media

missed the bid for Trump, focuses on the polarization that has been brewing for years.

Mark said this on a recent podcast.

It's even a term for that called a threat in majority.

That they tend to start becoming more radical in politics and start seeking out more

as no political entrepreneurs or candidates that speak to ethnic grievance more.

And that was what we saw in the United States.

There's also a deeper fragmentation underway in how Americans consume reality itself.

Pew's 2025 work on media trust showed Republicans and Democrats not merely preferring different

outlets, but often mirroring one another in trust and distrust.

For example, 58% of Democrats trust CNN while 58% of Republicans distrust it.

On the other side, 56% of Republicans trust Fox News while 64% of Democrats distrust it.

That kind of split does not just produce polarization.

It produces separate informational universes, which makes shared political outcomes harder

to accept.

Half the country thinks the 2020 election was stolen.

The other half thinks that that is an absolutely outrageous claim.

Abortion, guns, immigration, taxes, climate, health care, gender identity, affirmative action.

On each of these, one side is convinced that the other is simply on the wrong side of history.

There's no scope for compromise when this is the case.

Then there is the international dimension.

Domestic political fracture in the United States does not stay domestic.

Allies watch American elections, not as spectators, but as stakeholders, because the continuity

of US policy has clearly become less certain.

The erosion of America's standing internationally is no longer a matter of conjecture.

It's now quantifiable, and the numbers among our closest allies are striking.

According to Gallup's 2025 survey of all 31 NATO member states, median approval of US

leadership fell 14 percentage points to just 21%.

A level comparable to the low watermarks of Trump's first term and the George W. Bush years.

Germany saw approval crater by 39 points in a single year, Portugal by 38, and across

the Nordic countries, Sweden, Iceland and Norway, approval sits around 1 in 10.

Perhaps most sobering, Washington and Beijing now receive nearly identical approval ratings

across NATO, with China at 22% and the US at 21%.

The deterioration in European public opinion has been equally swift and measurable.

The spring 2025 Eurobarometer showed the positive views of the US among EU citizens collapsed

from 47% in October 2024 to just 29% by March of 2025, an 18-point drop in a matter of months,

with Denmark experiencing the most dramatic fall from 47% to 13%.

Across the EU, unfavorable views of the United States have now jumped to 67%, meaning

the US scores no better than China in European public opinion.

The security dimension is equally troubling.

In every European country, surveyed by the Institute for Global Affairs, fewer than 10%

of respondents were fully confident that a NATO article five would trigger an American

military response.

In March 2025, European poll placed Trump's trust score at just 2.6 out of 10, second worst

among 14 world leaders, behind only Vladimir Putin at 1.5, a data point that would have

been unimaginable just a few years ago.

Rogue-offs warning that dollar privilege rests on the perception of American stability

and trustworthiness is not abstract.

It is being stress tested in real time, and the early returns from our allies are not reassuring.

Trade relationships have been redrawn more abruptly and arguably in haphazard fashion.

Security commitments are being offered with greater conditionality.

Amongstanding alliances increasingly look less like treaty-bound arrangements and more

like relationships subject to political improvisation.

The result is not just geopolitical anxiety abroad, it is a subtle repricing of US reliability.

Alex Kazan framed it this way.

The administration views access to the US market as its primary point of leverage, and

so negotiations on any set of issues, even if they aren't purely economic issues, that

is a point of leverage, access to that market.

So the active use of trade policy, of investment policy, of tax policy, in order to further

other policy gains, that's been, I would argue, the defining feature of the Trump administration

from a global perspective.

One of Trump's gifts as a politician is his flexibility.

Because he's untethered to any real ideology, he's often able to pursue highly unconventional

policies.

But on tariffs, he's had a strong view for years.

Libby Cantrell said this.

You just sort of look at President Trump, where did he spend his time as a public figure

of a private citizen in the 1980s?

He was really focused on trade deficits, at that point it was mostly with Japan, but he

was very consistent in terms of his view that trade deficits are bad, that they're effectively

a scorecard between the US and the rest of the world, that tariffs are good, not only

as sort of a means to an end, in terms of leverage over negotiating partners, but also an end

to themselves.

He really believes that tariffs work in terms of making manufacturing in the US industry

more broadly, more competitive.

He was against NAFTA in the 1990s.

He was against China's session to the WTO in the early off.

On tariffs and now war, Trump's playbook is becoming better understood.

Here's how Alex Kazan described the strategy on international trade.

You escalate to de-escalate, and what I mean by that is you start by throwing out a bunch

of obstacles, and it's really to build leverage to gain what you want in more of a steady

state coming forward.

The problem is you risk not ever being in a steady state after.

And this is certainly true.

We saw the giant climb down on April 9th of 2025.

After driving the VIX to the mid-50s, generally an unwelcome development, and swap spreads to

substantial inversions, also unwelcome, Trump responded to best-in-sclaims for NOMAS.

A big, fat, never-mind, over a mid-afternoon tweet lifted the triple-q by 12% on the

day, the third largest one-day up-move since 2000.

But Trump, strangely, does have a strong view that tariffs create wealth for your country.

Libby Cantrell said this.

We think the president believes that tariffs work.

He believes that trade deficits are bad, and as a result, I think we should expect trade

policy to be volatile, to be a source of volatility over the next three years in a tariffs

room or main high.

Of course, for now, given the focus on Iran and the court's judgment that tariffs in their

current form were not legal, trade negotiations are off the front page of the Wall Street Journal.

In the movie, starring Bud Fox and Gordon Gecko, it was called the Wall Street Chronicle,

by the way.

But let's put tariffs and the Iran War as examples of the United States acting in increasingly

unilateral fashion.

In 2003, the Bush administration devoted enormous diplomatic capital, roughly 18 months

of it, to building international legitimacy before the invasion of Iraq.

The framework was explicitly multilateral.

Colin Powell's February 2003 UN Security Council presentation was designed to persuade skeptical

allies with intelligence evidence, however flawed it later proved.

The U.S. sought to assemble not just military partners, but political cover.

The coalition of the willing ultimately included 49 nations.

The contrast today is stark on almost every dimension.

Military action came first, coalition building was not a precondition.

Only Israel is fully on board with the U.S. Israeli strikes on Iran that began in June

2025.

The European response has been fragmented and reluctant rather than enthusiastic.

France's Macron warned military action outside international law risks undermining global

stability and called for emergency UN discussions, while the U.K. under Kierstharmer initially restricted

U.S. use of the Diego Garcia base.

When Trump did seek Allied help specifically around securing the Strait of Hormuz, the

string of refusals indicated his stock of European goodwill was low, having put allies

through the ringer over tariffs, Greenland, and other issues.

None of this is to suggest that a confrontation with Iran was not building and necessary.

It is to highlight the go-to-lone instinct of Trump.

I recently watched the Apprentice.

No, not the show that made you're fired, famous two decades ago.

Rather, the Apprentice movie about the Donald under the tutelage of Roy Cohn that was released

in 2024.

It's worth a watch and Jeremy Strong is exceptional as always.

We learn a lot about how Trump was taught to think in the movie The Apprentice.

Roy Cohn's three rules.

How do you win?

You want to know how to win?

I'm going to let you win a little secret.

There's rules.

Roy Cohn's three rules of winning.

The first rule is the simplest, attack, attack, attack.

Rule two.

Admitting nothing, didn't I, everything.

Rule three.

This is the most important rule of all.

No matter what happens, no matter what they say about you, no matter how beaten you are,

you claim victory and never admit defeat, never admit defeat.

So with tariffs as with war, Trump follows a similar playbook.

Aggress substantially.

See what happens and then react to what happens.

We're going to hit them as hard as ever, quickly becomes talks are going well.

A day later and re-escalation has occurred.

Hopefully, Susie Wiles isn't speculating on Polymarket.

It should be clear, this is not the ideal setup for prudently allocating capital.

I'd like to finish this less than optimistic discussion on two topics, the 2026 midterm

elections in U.S. fiscal dynamics.

Back to my four risks, economic, monetary, financial, and geopolitical.

Here a weakening of our capacity for effective governance threatens our financial condition,

possibly leading to a self-imposed risk premium.

Again, what we are doing is simply noticing things and asking whether what we see is sufficiently

priced.

Now is a good time to repeat one of my sayings on volume risk.

And that is, politics like asset returns are not normal.

We know that indices like the S&P are famously leptocritotic or fat-tailed.

Any conversation, by the way, that includes leptocritosis is a good one.

For the S&P, there's no model using the normal distribution and a reasonable volatility

assumption that allows for a 20% one-day plunge as we saw on October 19, 1987.

Stock returns are not normal.

And neither are politics, especially U.S. politics and especially today's version of them.

This brings us to the election cycle in the 2026 midterms.

Midterms are often treated as a referendum on the incumbent administration, but in the

current environment, they may be something more consequential.

They may become another stress test of the country's election infrastructure, legal norms,

and administrative legitimacy.

We are in an era where every close election has the potential to become a procedural contest.

Undercounting rules, certification disputes, court challenges, district maps, ballot access

and federal versus state power are no longer arcane matters for election lawyers.

They are becoming market variables.

And tied to this is the redistricting fight.

Redistricting used to be something most investors ignored completely.

Now it sits inside a broader struggle over the rules of representation and control.

The issue is not simply who gains a few seats in the House.

It is that repeated rule fights reinforce the perception that politics is no longer a contest

within stable guardrails, but an argument over the guardrails themselves.

Once investors begin to sense that the legitimacy of the system is regularly up for debate,

they should at least ask whether U.S. assets deserve the trade with the same institutional

discount rate that they once did.

Our politics are a civil war in which the objective is to win at any conceivable cost.

Right now the Trump presidency is on the wrong side of polls and thus the midterms.

The SAVE Act, formerly the Safe Guard America Voter Eligibility Act, now reintroduced as

the SAVE America Act is ostensibly about preventing non-citizen voting.

Democrats will say that the evidence available shows that this problem barely exists.

Several people, myself included, and a giant share of voters' favor voter ID.

Pew research found that 83% of U.S. adults favor requiring government issued photo ID to

vote, including 95% of Republicans and 71% of Democrats.

The legislation has become, in Trump's own words, his number one priority.

One he has declared so urgent that he vowed not to sign any other bills until it passes.

The bill passed the House in Feb 26 by a vote of 218-213 with only one Democrat in support

and now sits in the Senate where it faces a 60-vote filibuster threshold that Republicans

holding just 53 seats cannot clear.

Democrats warned that Trump appears to be constructing a pretext.

If the bill fails and the Republicans lose seats in November, he will have already laid

the groundwork to claim the elections were rigged.

The cynical view is that the bill may have been introduced to make the point that elections

aren't secure so that a loss can be contested before a single vote is cast.

Trump himself told Republican lawmakers that passing the Save Act will, quote, guarantee

the midterms, adding, quote, if you don't get it, big trouble.

For anyone watching the arc from 2020 forward, that framing should sound familiar.

By the way, Kalshi has a healthy dollop of political bets waiting for you to entertain.

The blue tsunami is the parlay where the dams take both the House and Senate.

It's one of the few lines going up these days.

It's now nearly a coin flip at 47% having started the year as a one and four chance.

Trump in case you haven't noticed does not like to lose.

This entangling the components of the risk premium embedded in a security is always difficult.

Ten year yields are currently up substantially since the start of the U.S. Iran conflict,

mostly on the back of higher inflation expectations.

Is this contested midterm election scenario priced?

I can't say for sure, but I don't think so.

It's not just Trump that calls foul on election integrity.

The data on election confidence is striking, not just for how low it has fallen, but for

the way it has become a mirror image of itself flipping entirely based on who wins.

Heading into 2024, Gallup recorded a 56 point partisan gap in confidence that votes would

be accurately cast and counted.

84% of Democrats expressing faith in the process versus just 28% of Republicans.

The latter having fallen 16 points from even their 2020 level and down from a majority

of 55% is recently as 2016.

An AP poll from the same period found only 22% of Republicans held high confidence that

votes would be counted accurately compared to 71% of Democrats, a near perfect inversion

of where each party stood in 2018.

Even Trump won and the numbers flipped.

Post election, it's found that 66% of Republican voters expressed confidence in the fairness

of the 2024 results, while Democrat confidence fell to just 44%.

And 63% of Republicans simultaneously maintained the 2020 election have been stolen.

What this tells us is that election confidence in America has become almost entirely outcome

dependent, less a measure of institutional trust than a running score of how your team

did.

If the losing side in any future election begins from a baseline of deep skepticism, the

question isn't whether there will be controversy, it's how severe.

I think the odds are non-trivial that this conflict spills out into the open, consuming

our news cycle and possibly impacting market prices.

Everything is an action and then a reaction.

In this context, we need to watch the ratings agencies.

Two recent downgrades of the U.S. sovereign, one by Fitch and one by Moody's, have cited

not just the unsustainable debt trajectory, more on that in a second, but also the erosion

of governance, the main topic of this podcast.

Here's what Fitch said in the press release accompanying its August 2023 downgrade.

Quote, in Fitch's view, there has been a steady deterioration in standards of governance

over the last 20 years, including on fiscal and debt matters, notwithstanding the June

bipartisan agreement to suspend the debt limit until January 2025.

The press release goes on to say, quote, the rating downgrade of the United States reflects

the expected fiscal deterioration over the next three years, a high and growing general

government debt burden in the erosion of governance relative to AA and AAA rated peers over

the last two decades that has manifested in repeated debt limit standoffs and last-minute

resolutions.

Unquote.

If I am correct, and there's escalation of the U.S. political war around the 2026 midterms,

we should expect the ratings agencies to weigh in.

Here, Mark Rosenberg did not mince words.

I'm trying to choose my words carefully because I still am an employee of Fitch.

But from my perspective and from the perspective of the geoquant data, the U.S. should be downgraded

again based on its level of governance and political risk and institutional risk, just

given where it sits relative to other developed markets.

Now layer onto all of this, the fiscal backdrop, because this is where political risk and market

risk truly converge.

The United States is running deficits at a scale that would historically have been associated

with recession, war, or national emergency, yet it is doing so in a period of low unemployment

and reasonably good nominal growth.

That tells you something important.

The fiscal imbalance is no longer cyclical, it is structural.

The wedge between what the government spends and what it takes in is become embedded in

the system, and neither party has shown much political capacity to close it.

The agency costs are immense, and if anything, polarization makes it harder.

One side resists tax increases, the other side resists entitlement reform, and both have

incentives to promise more than they are willing to finance.

That matters because debt dynamics are not just an accounting issue.

They are a confidence issue.

As debt rises and deficits persists, treasury issuance must be absorbed by an investor base

that may become more price sensitive over time.

At the same time, interest expense rises, which worsens the deficit, which requires more

issuance, which can lift term premium further.

It does become a reflexive feedback loop.

For years, the US benefited from deep foreign demand, reserve manager sponsorship, and the

belief that treasuries occupy the category of their own.

But if foreign official demand becomes less dependable at the margin, or if geopolitical

realignment weakens the appetite of traditional buyers, then the treasury market becomes more

exposed to ordinary market discipline.

And then we arrive at the place where political risk and market risk truly meet the fiscal

position.

Here the numbers are stark.

The CBO's February 2026 outlook projects a $1.9 trillion federal deficit in fiscal 26.

Deadheld by the public is projected at 101% of GDP in 2026, rising to 120% of GDP by 2036

above the previous record set just after World War II.

The CBO also projects net interest outlays rising to $2.1 trillion per year in 2036, or

4.6% of GDP.

Meanwhile, the CBO said the actual 2025 deficit was almost 6% of GDP in an account.

That was not in recession.

That last point is crucial.

These are not classic cyclical deficits associated with recession or emergency.

This is a structurally large gap between what the government spends and what it takes in during

a period of ongoing expansion.

In other words, the fiscal deterioration is not an accident of the cycle.

It's becoming a feature of the system.

And politics makes it much harder to fix.

One party has little appetite for higher taxes.

The other has little appetite for entitlement reform.

Both parties remain comfortable making promises that expand the fiscal burden.

Polarization doesn't just make politics louder.

It lowers the probability of credible fiscal consolidation.

That matters because debt dynamics eventually stop being a bookkeeping story and start becoming

a confident story.

The treasury market has long benefited from a kind of exceptionalism, deep liquidity,

reserve currency status, foreign official sponsorship, and the belief that US paper occupies

a class of its own.

For years, the Fed accumulated bonds even during periods when there was no emergency.

Bernanke and Yellen's bid was completely price insensitive.

From 2011 until the end of 2016, 10-year real interest rates averaged 19 basis points.

The current level is 2.1%.

A market financed more by price sensitive private buyers and less by the country's central

bank and official reserve managers is a market that may require a higher term premium.

And when the borrower is the United States, even a modest change in the required compensation

becomes a global event.

And that is really the point.

Political risk in the United States does not need to culminate in some dramatic constitutional

rupture to matter for markets.

It only needs to alter the probability distribution.

It only needs to make investors ask for a little more yield, a little more optionality,

a little more compensation for uncertainty around policy, fiscal direction, and international

credibility.

A modest repricing in the issuer of the world's benchmark collateral is not a modest event.

It's a global event.

Here's what Mark Rosenberg shared.

He's now in a space where the US sovereign could be the source of that crisis.

And that is a fundamental change in the way that I think investors should think about

global financial markets.

That doesn't mean that the S&P 500 is going to crash.

That doesn't mean that the dollar is no longer the reserve currency that Treasury yields

aren't still the cleanest, dirtiest shirt in the global economy.

But what it means is that the expectation that the US sovereign will act and has the tools

to act to a lay or seriously mitigate the next financial crisis is seriously in question.

The question is whether political dysfunction is becoming durable and meaningful enough

to impact market clearing prices by weakening the dollar and increasing the cost of credit.

Ultimately, this is a market risk premium that is a proxy for a weakening view of the

credibility of American institutions.

And that may be the biggest change of all.

For decades, the United States exported stability and imported capital.

Today, it risks exporting uncertainty while asking the world to keep financing it at

privileged prices.

That is not an equilibrium that should be taken for granted.

The challenge is to writing the ship are certainly about our fractured politics.

But they are also about math.

Here's what Libby Control had to say.

There's this joke that the government is basically an insurance company with an army

attached to it.

And that's what the budget looks like, 60% entitlements, 13% defense, and then the balance

is what's called non-defense, discretionary spending, and then interest expense.

So, especially if you're not getting into the real source of the expense, you're not

going to actually change the trajectory.

Alex Kazan did have a more sanguine take.

I don't overstate it where we're talking about the U.S. is having a crisis of governance

that will undermine faith in the robustness of our financial system.

I think we're incredibly far from that.

I don't think that the dollar-based financial system is going away anytime soon because

all of this is a relative game.

And for all of the challenges that the U.S. is going through, much of the Western world,

many developed economies are going through similar challenges.

Of course, very likely correct.

This is certainly a low probability event, playing for a U.S. government debt event might

be like waiting for Godot.

But while unlikely, it sure would have a high impact.

I'm only here to make the point that while the probability remains low, and perhaps extremely

low, there's good reason to believe that it is underappreciated by way of market prices.

So we should be contemplating the implications for additional risk premium in the U.S. government

bond market and what that means for the sister asset classes.

It strikes me that corporate credit protection could be cheap in such a scenario.

Interest rate vol, the shape of the yield curve, the pricing of FX vol.

These are all really interesting prices to do some thought exercises on.

Should these unhappy scenarios actually unfold?

Well, that is it for me.

Remember, risk management suffers from a failure of imagination.

We've got to keep thinking through this stuff.

As we do, let's hope that Kalshi and Polymarket don't have bets on there around the timing

of the U.S. default.

That wouldn't be a great sign.

I wish you an excellent week, and I'll catch you next time.

Be well.

You've been listening to the Alpha Exchange.

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