The Bogeyman Is Loose!
Rumors swirl… that an abominable bogeyman has risen from the grave… and that he is hot for blood.
He is the scourge of Washington. He is the dread of Wall Street.
This fee-fi-fo-fum’s return — if the sightings can be authenticated — would have markets wriggling in exquisite torture.
What precisely is this creature? And why is he now climbing from the grave?
Answers to follow. First we look in on his ultimate destination, the potential scene of carnage — Wall Street.
No Fears Today
The Dow Jones Industrial Average leapt a lovely 341 points today. The S&P 500 advanced 30 points; the Nasdaq Composite, 83.
We are informed that software firm Salesforce led the happy way forward on the strength of its latest quarterly report. Its stock climbed 11.5% today.
Meantime, 10-year Treasury yields crossed 4% today for the first occasion since November.
Yahoo Finance hints at the above-described devil’s potential menace.Enter now the protagonist of our frightful and ghoulish tale…
The bond vigilante. The bond vigilante is the monstrous villain detailed above.
The Rise of the Bond Vigilante
Wikipedia defines a bond vigilante thus:
Economist Ed Yardeni hatched the term in 1983.
“If the fiscal and monetary authorities won’t regulate the economy,” argued Yardeni, ”the bond investors will. The economy will be run by vigilantes in the credit markets.”
The Federal Reserve overheated the printing presses in the 1970s.
Inflation had America by the snout — attaining a dollar-devouring 11% by 1979.
It was during this period that the bond vigilante acquired existence. Here is the reason:
Inflation gnaws at the value of bonds as a termite gnaws at pine. And no bondholder is willing to see inflation reduce his bonds to sawdust.
In protest, they threatened to jettison their bonds en masse. This mass bond selling would spiral bond prices to obscene heights and bond yields to obscene depths.
Recall, bond prices and bond yields exist in a state of antagonistic polarity. If prices increase yields decrease. If prices decrease yields increase.
Imagine a seesaw in operation and now you have the picture.
Paul Volcker Routs the Vigilantes
But Mr. Paul Volcker came on station in 1979. “Tall Paul” elevated interest rates so high he licked inflation by 1983.
The bond vigilantes sank into a long, long hibernation. They re-emerged briefly in the early to mid-1990s.
A certain fellow from Hope, Arkansas — perhaps you recall him — planned to open the national cheque book… and spend.
But the awakening vigilantes jammed a gun against his ribs. Ten-year yields jumped from 5.2% to 8% between October ’93 and November ’94.
Thus the bond vigilantes forced Mr. Clinton “to scale back an ambitious domestic agenda,” in Yardeni’s words.
Such was their might, Clinton henchman James Carville adjusted his reincarnation plans:
Back Into Hibernation
But massive central bank bond purchases following the financial crisis hammered bond yields down and down (increased bond purchases raise the price and depress the yield — recall the swinging seesaw).
By July 2016, 10-year Treasury yields plunged to a record low 1.37%.
Inflation was reduced to a ridiculous rumor. And the bond vigilante was laid away for good.
10-year yields would plumb unfathomable depths in July 2020, under impossible pandemic pressure — to an inconceivable 0.53%.
But the pandemic occasioned the greatest monetary and fiscal spree ever witnessed.
Within 24 months, the Federal Reserve conjured 50% more dollars… than all the dollars that ever existed in 246 previous years of American history.
Can you imagine it?
The Return of Inflation
Unlike quantitative easing — which largely imprisoned dollars within the banking sector — the fiscal authorities emptied trillions into actual economic circulation.
In 2021 inflation got up on its legs and began to stretch. By June 22 inflation ran riot… summiting 9% last June.
All the while bond yields were on the jump.
From the pandemic trough of 0.53%, 10-year yields skyshot to 4.07% in October. There they presently remain — at 4.07%.
Thus bondholders are yelling for greater yields to jog ahead of inflation.
That is, the bond vigilante is climbing from his grave… and taking to the prowl.
Mr Simon White, Bloomberg macroeconomics crackerjack:
What then are the implications of this bond vigilantism?
In reminder: contrary to the beliefs of many, the Federal Reserve does not directly manhandle the 10-year Treasury yield. It only has its hands on the federal funds rate — the overnight rate at which banking institutions lend.
The Federal Reserve may influence the 10-year Treasury note, it may blow against it, it may speak to it. But it exerts no direct control over it.
“Inflation Is a Social and Behavioral Phenomenon as Much as an Economic One”
Please continue, Mr. White. We would like you to articulate inflation’s effects on the bond market. Tell us how inflationary expectations seep into the marrows:
It would also mean an end to the uneasy alliance between central banks and markets fostered over the last four decades.
It would likewise represent the triumph of the bond vigilante.
We wish him every godspeed and success. Strength to his arm!
Three Cheers for the Bond Vigilante
Here is the watchman of fiscal honesty. Here is the sentinel watching over the national purse.
Here is Horatio on the bridge, taking his defiant stand for the Republic.
He may be the only reliable check against breakaway federal spending and its attending debts.
Thus do we raise a robust hymn of praise for the bond vigilante.
Of course… he could potentially haul down the stock market to frightening depths.
Yet we must raise this question:
If the stock market would sink under the weight of sound finance… What does that say about the stock market?
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