Blain’s Morning Porridge August 26^th 2025 – Towards QE v.2 – Even bigger and more distorting.

 “”Oh no, not again,” thought the bowl of petunias.

The Fed has fallen. What will negative real yields do the US economy? It will likely further fuel asset speculation and lead to renewed QE as global buyers exit the US bond market. Using inflation to wipe the budget deficit may even be part of the plan. The path ahead looks increasingly fraught. Been here before.

This morning’s photo is not great quality. It’s one I snapped from my boat as we sailed back for holiday late last week. It’s a half-empty container ship sailing into Southampton, one of the UK largest container ports.

Container ships should never be this empty. Yet this one was. The next one – which was sailing out – was only 2/3 full – the waterline was high, and its bow bulb was right out the water. The critical indicator of global trade, the Shanghai Container Index traded up following Trump’s TACO back-down on China tariffs. Now it has plummeted again. The inference is Global Supply Chains and Trade remain in turmoil – again. A cold trade war is in prospect: Rare Earth supplies vs Tariffs. I leave you to draw your own conclusions where the global economy may be headed.

(Meanwhile, tribulations in Blain Manor this morning. While sailing at the weekend, She-Who-Is-Mrs-Blain slipped, fractured her knee-cap and dislocated it. She has crutches, knee brace, in pain and immobilised. I am not a natural Florence Nightingale – but will try!)

Back to the markets…..

Have you ever felt like an out-of-control roller-coaster just jumped the shark? In times of crisis momentum tends to develop a momentum all of its own….

While sailing round Southern England through August I was watching the global situation with mounting concern. I get that 2008 deja-vu all over again. The fruitless ructions over a Ukrainian peace deal, the assaults on the Fed, the increasingly “manufactured” political tension in the UK over immigration, and the mounting consequences of the “new” America on global trade relationships filled me with dread. These will all prove consequential, and I suspect will lead to increasingly chaotic outcomes. Noise, sturm et drang, and inconsistency is undermining confidence and investment.

On the upside, as always, periods of mounting instability will offer opportunities amidst the coming mayhem!

I am not an uber-bear. Markets are far more resilient than we think – which is why my most important market mantra is: “Things are never as bad as we fear, but seldom as good as we think.” In the face of the multiple challenges Trump V2 has presented, the ongoing strength of markets has surprised many market commentators and political critics – including myself. The US economy has been knocked by Trump’s actions, but remains in fundamentally strong shape.

But now it feels the challenges are mounting. The momentum towards a bust feels like it is building.

• Trump’s de facto sacking of Fed Governor Lisa Cook – paving the way for the presidential capture of the Fed’s decision and rate setting process – spells the end of central bank independence.
• The FBI’s ransacking of Trump dissenter John Bolton’s office and home demonstrated Trump delivering on venality and vindictiveness – but, that is what America voted for.
• The failed Ukraine peace process has left Europe increasingly detached from US “leadership” – creating a new void.
• 2 week’s ago I jested Intel’s CEO would come out his White House beasting intact by giving Trump a share of the business, and that’s exactly what’s happened. Which firm will be next for a DC shakedown?
• The AI everything rally looks increasingly exhausted. How much further can it go?
• How much more can western consumers stand – flat-line earnings, mounting inflation, and declining savings?
• When it busts – will it be a correction or a crash? (I favour a correction, and them put your buying boots on and lace them up tight – I shall explain below.)

The clue is in the bond market.

On Friday, beleaguered Lame-Duck Fed Chairman Jerome Powell effectively announced further easing at his swansong Jackson Hole Symposium. It will please Trump and stocks rallied. But, but, but and but, the yield on the benchmark 10-year US bond yield rose from 4.25% to 4.3% – reflecting the bond market reality: easing rates into an inflationary outlook and a still strong employment outlook might be politically expedient, but is likely a bad thing.

I wonder where we are headed in the USA with the coming collapse of Federal Reserve’s Independence. We know the USA is likely to suffer an inflationary tariff impulse – it will be less than feared, but still significant, boosted by imported inflation from a lower US dollar as interest rates fall, and global confidence in the US wobbles. Nobody buys long bonds in a period of hefty inflation – why would you? Compound inflation is as strong a force as compound income… Spend a $100 dollars today on a 30 year bond, and you will get $4.93 per annum (semi-annualy), but if inflation remains at 3%, then the $100 you receive back in 30 years will be worth the equivalent of $40 today, but only $30 if inflation rises to 4%! A 10-year bond will only be worth $75 when it matures at 3% inflation.

Reading between the lines of what Scott Bessant has been saying about funding the US with short-term debt – he understands long-dated bonds will be unattractive – suggesting its just a short-term prolem. He will restructure the Treasury market to reflect this. It could make Treasuries even more vulnerable; banks which fund themselves short and lend long have very short half-lives. Even more so nations.

What happens when the US treasury market fails to find buyers?

I predict Trump’s tame Fed Board will vote for a massive ease in US rates at the earliest opportunity – of course they will. The bond market will say no, and Treasury Yields will remain stubbornly high. The new Fed governors will be harangued and ranted at to lower bond yields, which they do by instituting QE2 – a massive Fed Bond Buying Programme (quantitative easing) to force rates lower. The effect will be to pump massive amounts of unfunded liquidity into the financial system, lowering the risk-free Treasury rate back into negative real territory. Cutting bond yields to zero may ultimately reduce the cost of government debt, but only by seriously distorting relative returns, and creating a massive boom – again – in financial assets. Happy days? Probably not…

The Fed will end up funding the US Treasury market… and everyone will struggle to understand how… No matter. Trump is a financial genius….

This is what happened in 2010 when QE and plentiful liquidity did nothing for the economy, but created massive inflation in financial asset prices – the post GFC equity rally that continued right till 2023 and central banks came to understand the monster they’d unleashed. If you held financial assets – happy times!

It is likely to happen again, because that’s the direction Trump is most likely to direct his Fed to follow – what’s not to like about a president under which financial assets are booming, creating the illusion of robust economic and business strength?  The fact the economy will still be flatlining as corporates scale back real investment in favour of stock buybacks at low interest rates…. will be lost on the electorate.

And the world has changed. When all global trade was transacted in dollars, that mean enormous sums of dollars entrusted to global banks would be invested into Treasuries. That is no longer the case – dollar trading is falling.

The triple whammy of dollar weakness, a treasury sell-off, and a resumption of QE distortions are just one nightmare scenario – but pervesely it’s one the short-terms focused markets will probably welcome, seeing a return of QE as the signal to invest “bigly” in all kinds of speculative assets. I never thought I’d ever write this, but even Bitcon could be a buy in the false frenzy that will follow.

What will be different about the coming QE distortion will be inflation.

I read a fascinating article outline how corporates will stick customers with the full cost of tariffs – gradually. At first they will tell the media they are absorbing as much of the cost as they can. Then they start to soak the consumer with incremental increases. Within 6 months the entire cost of the tariff will have been passed on to consumers – plus a little bit extra to reflect higher prices and their additional costs. Although the scale of tariff inflation may be less than originally feared because of goods and services not tariffed, eventually, higher prices will change demand and trade, likely triggering further supply chain ructions.

One thing that potentially cures a debt crisis is inflation. Consider it the equivalent of the amputation of a frog’s leg. In time the frog might grow a new one – but it will never be the same, and the frog will be permanently scared, mentally and physically. Think what happened to Germany in the 1920s, and how the mindset of Europe 80 years later remained heavily constrained by Germany’s terror of galloping price rises.

Oh dear.. here we go again….

Out of time, and back to the day job….

Bill Blain

CEO – Windshift Capital

Author – The Morning Porridge

Partner – Shard Capital