The Return Of The Bond Vigilantes

The term Bond Vigilantes was allegedly coined by economist Ed Yardeni back in the 1980s, but it came to wider public notice during the Clinton administration when bond prices dropped sharply in response to the President’s then inflationary fiscal policies. Clinton political adviser James Carville said at the time, "I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

The Boys Are Back In Town

Well, it looks like the gang is back.  Yields on 30-year Treasurys touched 2.15%, the highest in a year, but more importantly the yield curve keeps steepening: the 10Y-2Y spread reached  123bp, the highest in five years.  The Fed may control the short end  (i.e up to 2 years), but beyond that it’s Vigilante territory.  And them bad boys are experts in gang warfare, and they pack serious heat. 

The Fed is presently committed to buying $120 billion in bonds every month, consisting almost entirely of the new bills and notes issued by the Treasury to finance its enormous budget gap, ie the Fed is  monetizing the deficit. 

It is very understandable to do so during the COVID crisis.  But, as the above numbers show, the Vigilantes are becoming more and more upset.  They haven’t attacked yet, but they are definitely starting to snarl.  The Oppo gang - Powell, Yellen and the ECB's Lagarde - may have very powerful short range weapons (Fed Funds and repo) but they certainly cannot buy every bond offered for sale in the secondary market. 

As of last month there were approx. $16 trillion in marketable Treasury notes and bonds outstanding (excluding the bonds held by Social Security). The Fed simply cannot absorb even a fraction of that amount, plus keep buying the flood of new issues coming from the Treasury.  

In gang terms, it’s a turf war that the Oppos cannot win.