Markets Wrap: Higher Yields, Higher Gold

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2:49Merryn Somerset Webb: welcome to the meron talks money market wrap where we talk about the biggest moves in the markets this week and what is driving them i'm meron somerset web uk money editor at large and i'm john steppik editor for god's sake who are you john who are you john's been on holiday everybody let's cut the man some slack he was only you've been at work for two days or something that's the longest stretch he's done for months for god's sake you've got to cut him some slack Who are you, John? Do you want me to help you? I'm going to do this for John, all right? So he can gather himself for the next bit.

3:19Merryn Somerset Webb: Okay. I'm John Steppich. Obviously, I'm not. He is senior reporter and author of the Money Distilled newsletter. Award winning. You never forget that bit. Forget your own name. Forget your job title. You don't forget your awards. Right. John, I think we have to start by talking about the bond market, right? There's a lot going on. Let's have a quick look at yields today. We are talking on Thursday the 20th. 30-year yields in the US and the UK are at multi-decade highs at this point. 10-year yields, the US is up near 4.7%, 4.68%. Japan is not far off 3%. Everywhere in the EU is knocking around 3 % and 4%.

3:58Merryn Somerset Webb: And of course, here in the UK, we are firmly over 5%. Poor list trust is all I have to say to that. Poor, poor list trust. Lost a job for a bond yield much lower than that. it's true it's a double standard it's almost like there's more than one tier involved more than one tier ah it's two tiers two tiers all right all right all right all right no no more um no what's it called no more dog whistling john that's what they call it right what's going on in the bond market well basically i mean bond yields have gone up a lot um and they are yes at multi-decade highs particularly at what is known as the long end of the bond market so you know way out above 10 years 30 years um and uh i mean this is because i mean this is actually for pretty logical reasons governments have spent a lot of money so there's a lot of bonds out there ai companies are spending a lot of money so there's even more bonds out there so there's an awful lot of supply and then on the other side we've also got the war in Iran continues that keeps on pushing the oil price kind of up and down but that also keeps feeding through to kind of diesel prices, petrol prices etc etc and so markets are also still concerned about inflation which also kind of pushes up bond yields.

5:24So what happened this week is that yesterday, Wednesday US Treasury Secretary Scott Besant clearly has been feeling edgy about this because earlier in the year he basically said to Japan look if you want to strengthen the yen I'm okay with that but I don't want you selling US treasuries instead you can borrow the money from us and that's how you can raise the dollars to strengthen the yen against the dollar and now with the latest thing what he's said is we're going to buy back double the number of long-end US treasuries that we were planning to this quarter. And basically what that involves is issuing more short-term debt to buy back in some of the 30-year bonds that are on the market.

6:13And they're where the most strain has been felt in terms of bond yields going up. So that briefly sent bond yields back down. but of course and i mean scott besant used to be a hedge fund manager so i'm sure he's aware of this as soon as you draw a line in the sand for the markets saying this is the thing that the government doesn't like and if you get to this number we will intervene they tend to push it so today the yield has already bounced back to where it was before they said right we're going to do this intervention so it's basically just gonna be interesting to see what happens next yeah i

6:53Merryn Somerset Webb: suppose the other thing says that this doesn't feel like a treasury secretary's job this feels like a fed job so this is the beginnings of what they call fiscal dominance right oh yeah i mean yeah i mean no you're absolutely right i mean i don't think it's particularly new. I think obviously the fiscal side of things has been intervening more and more and nudging central banks and the monetary policy element more and more. But it is getting more overt. And I do think it would be fair to describe this and I mean George Saravellos over at Deutsche Bank did say this is a soft form of financial repression.

7:33Because the desire is to cap yields in some way. And assuming that he does manage to cap yields the place where the strain will be felt is the foreign exchange market so it's it's all else being equal if he actually manages to put some sort of cap on long term yields the dollar is probably where we would feel it and the dollar would go down but i don't really see i don't think he particularly would care about that at this point because if you look at where the dollar is it's not actually particularly weak it's not mega strong but you know it was basically the kind of dollar index which is the dollar against all its you know partner currencies um is still a lot higher than it was for basically the whole of the 2000s um so i would think that if the trade-off was a weaker dollar for interest rates looking better and i guess being better because this will all feed into the u.s u.s mortgage market as well then that's a trade-off he would take but i think he's going to have to do more because otherwise the market's just going to say well, you know, they'll push them to the yield that it feels uncomfortable with and then say, okay, what are you going to do now?

8:45You know, we need to see you pull out some big guns here. It's going to take more than just saying, oh, we'll buy a few extra long-end treasuries to get rid of it, I think.

8:56Merryn Somerset Webb: And of course the line problem here is the thing that you and I have now been talking about for going on 20 years, which is the ongoing rises in government debt around the world that just keep going and going and going and going. And everyone feels like we're in a bit of an inflationary environment and you keep seeing debt rising more than GDP, over and over nominal GDP in different countries. And it just, there's got to come a point when something breaks somewhere. I mean, that's what you would think. And you know, I mean, presumably that's what Scott Besant thinks as well. and that's why he's hoping to hold this down.

9:34And I mean, I do think the... I mean, US government debt,

9:37Merryn Somerset Webb: the number this week is going through$40 trillion, right? Yeah. It's just so much money. Yeah, and I mean, it's also interesting that there's no, there's not really, like one difference between now and most of the time that we've ever been talking about this is there's usually at least one group of slightly obsessive people who are in politics and really want to see the debt and the deficit come down. I mean, that was the case prior to the great financial crisis. It was certainly the case after it. But now there is no political constituency for cutting spending, really. Certainly not in America.

10:20You know, and even here in the UK, it's very hard to find. And it doesn't matter where you sit on the spectrum from the furthest left to the furthest right. Everybody wants to spend more money.

10:34Merryn Somerset Webb: So I think absolutely nobody out there saying to get off this road to future misery, we have to reduce the size of government relative to GDP. And we have to see some massive rise in GDP. And I saw from MacroStrategy Partnership a note out this morning saying the US is getting 34 % of nominal GDP growth per dollar of additional debt. China is getting 18.8 cents. Yeah. I mean, they're just borrowing from the future in a completely absurd and unsustainable way. So, you know, if I were the bond market, geez, I'd be pushing up yields too, regardless of all the short term stuff. I mean, this may be what we need to see.

11:15But I think, again, the risk here is that, well, the US for example is able to get away with this for definite and other countries can get away with it to an extent. The issue will be that presumably if they manage to cap bond yields in some way then inflation will make itself felt more strongly because obviously if you get a weaker currency that will translate into imported inflation or more costly goods coming in. But yeah I mean I guess the fight can go on for quite a bit longer Assuming that this is That they take the steps that we think they would take to suppress bond yields

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12:50Merryn Somerset Webb: Charlie Morris, our old podcast friend Charlie Morris, wrote today that gold smells QE. and we see we did see a big jump in the gold price yesterday four percent or so um and obviously in an environment like this the gold price probably is gonna rise yeah i mean i see no reason to be bearish on gold right now and you know the other thing that caught my eye which i mean and also caught jally's eye because he likes his crypto as well bitcoin really took off in a way that it hasn't for a while and actually bitcoin gold have not been doing the same thing for for some time but i definitely think this is because people suddenly thought oh look this is it the debasement trade is absolutely back this is all about the weaker us dollar buy all the things that you buy if you think the dollar is gonna slide um and i think that's that's again i don't think that's an unreasonable conclusion.

13:52Merryn Somerset Webb: I asked a tech guy yesterday on one of the podcasts coming out next week, actually topless and do-less and on quantum computing and all sorts of fabulous things like that. I asked him, I haven't asked at the end of our podcast for a while, Bitcoin or gold. But given that we talk so much about quantum computing in this podcast, I thought I would ask him Bitcoin or gold, particularly as, you know, deep tech guy, right? And I wasn't entirely sure which way he would go, but he was very, very clear gold. Gold. Presumably he's a quantum guy, though he's worried about quantum destroying crypto. Yeah, Q day coming up.

14:27Merryn Somerset Webb: And then, you know, can anyone be bothered to go around the place? Well, you know, once you've got a quantum computer, you can probably use it for more exciting things than going around the place, breaking into people's wallets and stealing their Bitcoin. You're probably not going to. It's not going to happen. It's not going to happen in a hurry. It's way down the list of what happens when people get their hands on a nice quantum computer to the extent that they will in the short to medium term. but nonetheless the fact that they could is surely enough to make it useless to make it worthless yeah i mean to me for chris is chris woods over at clsa that or ex's clsa i think um he he was a bitcoin bull but quite recently sold out entirely didn't he because on that basis yeah yeah i mean that is interesting i would and actually i mean you're right i mean at the end of the day you don't need to wrap your head around it.

15:14Even if Bitcoin is digital gold, you might as well stick with the physical one that can't be disrupted by quantum. Although presumably gold could be screwed up if we get fusion energy.

15:25Merryn Somerset Webb: Yes. Because you'd probably make gold in a fusion reactor. Yes, I mean, you know, alchemy is currently possible. Just it takes so much energy that's not worth thinking about. Yeah. But one day. Anyway, moving on. Bonds, gold. If fusion power helps, we definitely don't have to worry about anything. The age of abundance that fusion power combined with AI and quantum will bring means that we won't need to worry about the gold buried under our house or not anymore. Everything's going to be so marvelous. Nothing to worry about. But on the matter of disruption, I wanted to talk briefly again about an academic report from Stanford University, which someone at Pamir Liberian pointed us to.

16:13Merryn Somerset Webb: And we've talked about this before. We've talked about whether the build-out of data centers is the right way to go, whether the future of AI really is all about large language models. Go back and listen to our podcast with Dr. Ginny Smarecki, anyone who wants the granular detail on this. But one of the things that he said was, look, you don't have to use LLMs anymore to get the same efficacy from your AI. You can use an SLM, a small language model, which you can run on your laptop or on your phone, and you get pretty much the same performance. And not only that, but you hang on to your own data.

16:57Merryn Somerset Webb: You maintain your privacy by using an SLM over an LLM. It's cheaper, uses piles less energy, and is contained. So the paper on this looks at how effective and how accurate SLMs are against LLMs. And I'll put the link to it in the show notes. I'm going to write about it in the Meritalks Money newsletter this week as well. But the basic point here is that if you look at all the tasks on reasoning tasks, SLMs are nearly as good as LLMs. They provide a better or at least as good an answer as LLMs in well over 60 % of the cases. Look at other tasks, real life tasks, this mixture of chat and reasoning performance.

17:45Merryn Somerset Webb: And on average, SLMs are as good, if not better, than LLMs in 81.2 % of the cases, with LLMs having significant advantage. I'm reading aloud here. A significant advantage only in areas like, I think he means such as, Let's stick with the grammar correctly, guys. That's what AI is for. Edit for your grammar. Significant run to only in areas such as engineering, life sciences, transportation, and computer science. But it's not just accuracy. SLMs achieved this performance at energy and compute costs that are between 50 % and 85 % lower than an LLM. So are SLMs like the search engine versions, basically?

18:28Like if you're just Googling or whatever, use that. if you're trying to cure cancer views in LLM.

18:33Merryn Somerset Webb: Well, I mean, maybe, maybe not. By October 2025, the SLMs achieved 99 % success for the easiest reasoning tasks in level one and two, 85 to 92 % in harder tasks, and only lagged in the hardest tasks of all, that be a cure cancer, where there's a 51.5 % success rate. So they're exactly right. There's only a very small number of very complex and vital tasks that you might want to use an LLM for, and the rest perhaps if what you're just trying to do is hang on to your data hang on to your privacy and do things at a low cost you would use an SLM yeah and if that is the case if that is the case and again neither you or I are experts on this stuff um if that is the case and the um the head that the title of this uh little bit of research says if this is true the hyperscalers are toast I mean link in the show notes

19:31the thing is I agree I mean I guess my problem is I'm trying to work out why I'm wrong if you see what I mean or why this is wrong because on the one hand you know we'll obviously get a natural scepticism I'd rather lean against it in these cases because clearly AI is a big deal

19:50Merryn Somerset Webb: um this is not to say it's not a big deal it's just to say it doesn't have to be done in this expensive way well this is it and also the even if you discount the slm llm thing i mean the chinese models are just as good or certainly seem to be nearly just as good as the most advanced ones in the u.s but they are not spending the same amount of money on the infrastructure and I do yeah I would need I would like somebody to kind of make the steel mine case for why it's a good idea to be building all of these data centers and what they're going to be used for if this all turns out to be essentially unnecessary or unnecessary in this volume it's a little bit it's a little bit like a little bit like wind power yeah And that on a really windy day in the UK, for short periods, we can support the entire electricity network from wind.

20:57Merryn Somerset Webb: So why are we building more? Yeah, yeah. It's, I mean, I guess, I suppose the other thing with this is that it all points to the data centers being, in a funny kind of way, they're kind of like peacock tails. It's like, you know what I mean? you get these whatever kind of like four hyperscalers kind of like building these massive ornaments because they can and it's almost like the last one standing is the winner because they kind of outspent each other um i don't know it's it's so i don't know john but your um your animal metaphors are getting kind of kind of interesting i mean i don't know if you remember the squirrel squirrels This is Britain's pandas.

21:45Merryn Somerset Webb: And here we are with data centers as peacocks. Yes. Data center infrastructure builders as peacocks. Look at my mighty edifice, which is of no value, but can be supported. Exactly. So let's hold that in your head, this whole SLM, LLM, Chinese LLM dynamic. And then let's go back to what we were talking about at the beginning when we were talking about the bond market. I mean, almost always you think, you know, yields up, equity market down. Yeah. But that isn't really happening at the moment. And if you read all the endless broker reports that you and I both look at all the time, what they do is they tell us that that dynamic isn't working at the moment or isn't working as it normally does because AI, because it's simply not sensitive to yields in the same way as historically major parts of the market has been because the demand is so great, the The need is so strong, the revenues are so high, and the future profits are so ginormous that a couple of percentage points here or there on the 10 and 30 year yield.

23:01Merryn Somerset Webb: Yeah, who cares? Yeah, that's not very convincing. Well, it's not, and it's particularly not if there is any truth at all in the idea that data centers are, I repeat, toast in the face of SLMs. yeah i mean it's gonna be it is gonna be fascinating to watch how it falls out and i suppose the the one the one sort of like it's a potential positive in a kind of negative way for the sovereign debt or at least for u.s sovereign debt is that if everyone is in a rush to get out of ai bonds at some point then you would sort of probably expect lumpy dash for the safety of u.s treasuries if it got that bad um i don't know it is this is this is one of those where i just think it's gonna be fascinating to watch because there's all this off balance sheet stuff that they've got as well all that other stuff yeah yeah i think john that we should probably end it there because we don't know the answers but we can just say to our listeners watch out for peacocks actually one tiny thing this is another reason why you should watch what's in your pension again if you don't know what's in your auto enrollment pension go and find out because there is more and more pressure to stick more and more money into private credit private assets all of the sort of stuff that will end up being exposed to the worst of the excesses of this particular build-out i suspect and the pressure to do that is going to keep mounting the more of this stuff that ends up spreading into the wider financial system so yeah just know where your money is and make sure it's not anywhere you don't want it to be another little personal finance heads up on that one by the way i was noticing earlier today let's talk about this is a uk specific point but um uh you know you get these whopping great inheritance tax bills and you can occasionally for very very non-liquid assets spread those bills out over a long time if you have you know maybe if the the asset in question is land or whatever you can arrange to pay the bill in in in bits um but i don't think that applies and it's under discussion at the moment anyway but i'm pretty sure it doesn't apply to say private equity holdings on your pension yeah so imagine if um you die with an awful lot of very very illiquid private credit and private equity assets which it might take five years or so to sell and your heirs are stuck with the IHT bill on that in the immediate then has to be sold at a discount just something to think about something it was wandering through my head today is it peacocks who are so aggressive that they're constantly attacking themselves in their reflections from other people's cars that's fair I have no idea I think they're both vain and aggressive I don't know I don't know I think that in the future maybe we should have a biology graduate or a wildlife expert sit in on these podcasts this is a great idea contact us if you'd like to be a wildlife intern

26:27thanks for listening

26:28Merryn Somerset Webb: to this week's Maren Talks Money Markets Wrap If you like our show, rate, review, and subscribe wherever you listen to podcasts. Also be sure to follow me and John on X or Twitter at MerinusW and John underscore Stepik. This episode was produced by Sam Asadi and Moses. And questions and comments on this show and all our shows are always welcome. Our show email is merinmoneyatbloombo.net.

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