Last Friday made it clear: trust is vanishing and SAP Banking is the antidote

The 10-Year Bond's Credibility Is Fading At first glance, the simultaneous rise in both stocks and 10-year Treasury bond yields seems contradictory. Traditionally, when bond yields rise—a sign of a strong economy and expectations of higher interest rates—stocks tend to fall, as the cost of corporate financing increases. However, this recent behavior reveals a shift in market perception, where the 10-year bond might be losing its reputation as an unconditional safe-haven asset. The primary reason behind this dynamic is the loss of investor trust in the 10-year Treasury bond’s ability to be both the most liquid asset and a reliable store of value. For decades, the U.S. bond has been seen as the world's safest investment. Its liquidity, or the ease with which it can be bought and sold quickly, was its greatest virtue. Yet, the growing and astronomical U.S. debt has introduced a new element of risk. Investors face the possibility that, even if the government doesn't default, the bonds' real value could be eroded by inflation, which is fueled by growing debt. The market no longer perceives the 10-year bond as a purely defensive asset. Now, its movements are increasingly sensitive to monetary policy expectations and the fiscal reality of the United States, making it an asset with greater volatility risk. This is why, following the recent Federal Reserve speech, investors not only reacted to the cautious stance on rate cuts (causing yields to rise) but also interpreted the economy's strength as a good sign for stocks, setting aside concerns about the bonds' impact. In a world where inflation and debt are persistent problems, the "flight to quality" into Treasury bonds is no longer an automatic move. The Link Between U.S. and Japanese Bonds This phenomenon is reflected in Japan's bond market, the main foreign holder of U.S. debt. Japanese government bonds (JGBs) have also experienced significant volatility. This is because the Bank of Japan (BoJ), to keep the yields of its own bonds low, has been printing money and buying a large portion of Japanese debt. This policy, combined with the BoJ's enormous exposure to U.S. debt, creates a crucial interdependence. If the U.S. 10-year bond reacts to the Fed's caution with a rise in its yield, the Japanese bond does too. An increase in the U.S. bond yield pressures the Bank of Japan to adjust its own policy, as the gap between the yields of both countries widens. This could trigger a sale of U.S. Treasury bonds by the Bank of Japan to strengthen the yen, which in turn would add more upward pressure on the yields of U.S. bonds. In this scenario, the behavior of the Japanese bond last Friday, which also experienced a rise in its yields, confirms this argument. The correlation and interdependence between both markets are clear: tensions in Japanese debt, fueled by the need to support its own bond market, are exacerbated with every movement in the U.S. bond market. This cycle reinforces the idea that the volatility and risks of sovereign debt are spreading worldwide, undermining the traditional perception of these assets as safe. The Domino Effect of "Margin Calls" Beyond the interdependence between countries, there's an even greater systemic risk at play: the loss of value in U.S. Treasury bonds affects the very foundations of capital markets. This is because the U.S. bond is, by far, the primary collateral of the global financial system. Derivatives markets, interbank lending, and "repo" operations (repurchase agreements) rely on the liquidity of Treasury bonds as collateral. When an investor or a financial institution takes out a loan to leverage a position, they often put up Treasury bonds as collateral. The value of this collateral is what allows them to get the loan. This is where the danger lies. When the value of Treasury bonds falls (because their yields rise), the value of the collateral decreases. This triggers "margin calls," which are demands from lenders for the borrower to put up more cash or assets to cover the collateral shortfall. A widespread increase in margin calls forces investors to sell other assets, such as stocks, to raise the needed cash. This creates a vicious cycle of mass selling, where the fall in bond value triggers the sale of stocks, which in turn can cause more instability in bond prices, leading to even more margin calls. The 10-year bond isn't just another asset; it's the central gear of the global financial machine. The erosion of its value as collateral could trigger a deleveraging spiral that would abruptly increase volatility across all markets, testing the stability of an already fragile financial system. The Only Antidote: Integrating the Real and Financial Economies The volatility we're witnessing can't be eliminated entirely, but it can be mitigated. Market panic is fueled by uncertainty, and the only way to combat it is with total transparency. But this kind of transparency isn't just about clearer speeches or more financial data. It requires something deeper: the integration of the financial economy with the real economy. The financial economy—the abstract world of bonds, stocks, and derivatives—is built on the tangible foundations of the real economy: factories, homes, consumer goods, and wages. The assets of the former are, in reality, collateral and underlying assets of the latter. A bond backed by a mortgage is nothing more than a promise of payment based on the value of a brick-and-mortar house. Similarly, the liabilities of the real economy—the debts of households and businesses—are the capital drain of the financial system. When a mortgage defaults or a company goes bankrupt, not only is the underlying asset lost, but capital is drained from the financial system. The volatility we saw is a symptom of a system that operates in the dark, with a fundamental disconnect between these two worlds. The only way to restore confidence and stability is through a transparency that unifies these two economies. Investors and regulators need to see how a move in the 10-year bond's yield affects not just derivatives markets, but also the ability of households to pay their loans or companies to finance their operations. This is where SAP comes into play. The company’s software manages an estimated 77% of the world's GDP. SAP has standardized the language in which the real economy communicates, controlling everything from the supply chain to cash flows. The company's system is the invisible bridge between the world of "atoms" (physical goods and services) and the world of "bits" (financial data). Yet, today, the data from the real economy, while it exists in SAP, remains a "black box" for financial markets. Only by closing this gap between the economy of numbers and the economy of people can we hope for "flight to quality" to regain its meaning and for the financial system to stop being a black box of incomprehensible risks. Real transparency demands that data on GDP, inflation, and central bank movements are fluidly and visibly connected to the underlying health of the businesses and households who use these management systems. Connect and Stay Informed: Join the Conversation: Connect with fellow professionals in the SAP Banking Group on LinkedIn. https://www.linkedin.com/groups/92860/ Stay Updated: Subscribe to the SAP Banking Newsletter for the latest insights. https://www.linkedin.com/newsletters/sap-banking-6893665983048081409/ Explore More: Visit the SAP Banking Blog for in-depth articles and analyses. https://sapbank.blogspot.com/ Connect Personally: Feel free to send a LinkedIn invitation; I'm always open to connecting with like-minded individuals. ferran.frances@gmail.com I look forward to hearing your perspectives. Kindest Regards, Ferran Frances-Gil.