Awakened after a long sleep: "The Bond vigilantes are coming back"

• Term was first coined in the 1980s
• UBS strategist: “The bond vigilantes are coming back and that is very important for asset prices”
• Bond vigilantes increasingly question Yellen’s policies

What are Bond Vigilantes?

“A bond vigilante is a bond trader who threatens to sell, or actually sells, a large amount of bonds to protest or signal distaste for the issuer’s policies,” as Investopedia explains. Selling the bonds ultimately causes prices to fall – thereby increasing interest rates and making borrowing more expensive for issuers. The term was coined in the 1980s by investor Ed Yardeni. At that time, bond traders sold their Treasury bonds in response to the Fed’s growing power and policies towards the US economy.

“The Bond vigilantes are coming back”

According to Kevin Zhao, head of the global sovereign and currency department at UBS Asset Management, the bond vigilantes are coming back. The reason for this is the prospect of higher interest rates in the longer term and a growing budget deficit, as CNBC reports. Just last Monday, the yield on the ten-year benchmark US government bond rose again above five percent, having exceeded this milestone just a few days earlier for the first time since 2007.

The current one was finally sold after Federal Reserve Chairman Jerome Powell promised monetary policy to continue trying to bring inflation back to its two percent target. The Treasury Department also recently announced Friday that the U.S. government ended the fiscal year in September with a budget deficit of nearly $1.7 trillion. In addition, there was a significant national debt totaling $33.6 trillion, explains CNBC. U.S. debt has increased by over $10 trillion since the outbreak of the COVID-19 pandemic in the first quarter of 2020.

Speaking on CNBC’s “Squawk Box Europe,” Zhao highlighted the historic sell-off in the bond market last September. This followed a “disastrous mini-budget” by former British Prime Minister Liz Truss, which also included a series of unfunded tax cuts. An example of bond investors defending themselves against what they consider to be irresponsible financial policies. “The bond vigilantes are coming back and that is very important for the prices of assets such as stocks, house prices, tax policy and monetary policy. So there is no longer a free pass for the bond markets – so the government has to be very careful about the future. This “We saw this with government bonds last September,” said Zhao. “A few months ago, most people assumed that the US federal deficit would continue to fall as growth slowed – last year it was 3.9%, and as growth slows it is actually rising – that’s for Quite alarming for bond investors.”

Other strategists share Zhao’s opinion

However, Zhao is not alone in his comments. Rather, they reflect the opinions of several strategists who have expressed themselves in recent weeks, according to CNBC. One of them is Ed Yardeni, President of Yardeni Research.

Earlier this month, he told CNBC that the Bond vigilantes had been “asleep for a long time.” Especially since inflation remained consistently low between the financial crisis and the corona pandemic. However, now that inflation has skyrocketed, they have woken up. “During the pandemic, we basically saw an experiment in modern monetary theory, helicopter money, money raining down on people’s deposits, and that was encouraged by loose monetary policy – well, monetary policy changed course and tightened, while fiscal policy went the other way and was far too stimulative, and the bond vigilantes are vigilant again when it comes to fiscal policy,” said Yardeni. “You’re basically saying, ‘Reduce this deficit significantly or we’re going to raise interest rates to a level that’s a drag on the economy, and then what are you going to do?’

In a Financial Times article, Yardeni explains that bond vigilantes have increasingly questioned Yellen’s policies in recent weeks, which is why they have raised bond yields to levels that threaten to trigger a debt crisis. In this situation, rising yields would result in the private sector being squeezed out, which in turn would trigger a credit crunch and economic recession. Since excessive fiscal policy is the main culprit for this problem, the government would have to reduce spending and increase taxes to appease investors. However, this would have the effect of worsening the economic recession.

Editorial team finanzen.net

This text is for informational purposes only and does not constitute an investment recommendation. finanzen.net GmbH excludes any claims for recourse.

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