Can “Bond Vigilantes” Ever Return To Scare The Fed Straight?
Submitted by QTR’s Fringe Finance
For all of the rockiness that markets endured in late November and early December – mostly stemming from the expectation that the Fed has totally lost control, is definitely going to taper and that inflation will run rampant permanently – the 10 year yield has spent the last few weeks shrugging things off and once again leading credibility to the Fed’s longstanding narrative of lower for longer.
And with the 10 year yield slipping over the course of the week last week, and falling about 16bps from highs in the middle of November, the question about whether or not “bond vigilantes” will show up in 2022 has started to present itself to me as pressing.
This is why I asked recent guests of mine, including former open outcry trader Jack Boroudjian, genial CNBC-guy Jon Najarian, trader Rosemont Seneca and hedge fund manager Chris DeMuth, their thoughts on the topic.
For those not in the know, bond vigilantes are loosely defined as “bond market investor[s] who protests against monetary or fiscal policies considered inflationary by selling bonds, thus increasing yield”.
In other words, they’re the ones that try to force the Fed’s hand to move rates higher by selling bonds, if it’s even possible anymore.
The first thing that needs to be considered is whether or not “bond vigilantes” are even possible anymore.
…the infamous bond vigilantes, who sold bonds to protest inflationary policies, are relics of the past. They were driven by opportunity, not ideology. These investors voted on government budget deficits and debt management by buying or selling bonds every day. But active Fed intervention has silenced them. “Fighting the Fed” has always been fraught with risk, but fighting a Fed operating with such force will result only in big and consistent losses.
But not everybody shares in this opinion. Some people just think bond vigilantes are waiting for their cue.
“There’s a day of reckoning coming,” former open outcry trader Jack Boroudjian told me a couple days ago.
He continued: “At what point will ‘the bond vigilantes’ come in and hit the bond market hard? That is the way the real world works, when you start to debase currency. That’s the way it should work. [Bonds] are being manipulated as they are, making it tough to gauge what real value is.”
When I asked if these bond traders have enough firepower to really affect change, Boroudjian said: “No. Not until the Fed’s out of the picture. There are people chomping at the bit to be able to [sell bonds]. But [not] until we start to see the Fed get to the end of the taper…”
Listen to the full hour long interview with Jack here: The Fed Makes It Impossible To Figure Out Where Real Value Is: Jack Boroudjian
“The Fed can’t prop it up forever,” hedge fund manager Chris DeMuth told me days ago. He continued:
“I have mixed feelings about [bonds]. As an equities guy, I have long suspected that the smart people are in credit. But I also suspected that they would have been far less tolerant than they’ve been. Argentina has defaulted on its debt an average of once every 23 years and today it’s 30-year yields just over 5% so maybe the US’ creditors will be as lenient.”
“The problem with the endless fiscal and monetary profligacy is that such moves were intended only for contending with real emergencies – winning a world war or emerging from a global depression. Now we’re just doing it because our pain threshold for short-term abstemiousness has reached zero,” he added.
Read my full interview with DeMuth here: “The Fed Can’t Prop It Up Forever”: Rangeley Capital’s Chris DeMuth
Also worth noting were the comments of Edward Yardeni, president of Yardeni Research Inc. earlier this year, who urged people not to discount bond vigilantes.
And perhaps he should know a thing or two about them. After all, he named them – and he also was on the lookout for the inflation we are seeing today, back about 6 months ago. He made the argument that bond vigilantes are even getting stronger, telling Bloomberg this summer:
I don’t think [bond vigilantes] are dead. Let’s see what happens tomorrow [with the inflation report]. Anecdotally my 22-year-old son walked into my home office. He just got a haircut. He said they raised the price from $20 to $26. When the barbers start raising prices, you have to worry about broad-based inflation.
I’m sticking with my call of 2% [yield on 10-year Treasury notes] by yearend. Inflation is going to be a little bit longer-lasting than the markets are anticipating.
It’s not as easy being a bond market vigilante now as it was in the 1980s. Then, the Fed didn’t intervene directly in the bond market. Give them even more credit for a valiant attempt to express an opinion when they’ve been gagged for so long by the central bank.
In a free, competitive market, the price mechanism works. But this is not a free market.
The longer the Fed keeps buying bonds, the more [potentially] powerful the bond market vigilantes are going to get because the compounding effect of higher rates on debt-service payments would be just a killer. We got a glimpse of that in 2017-18 when rates were going up.
While Yardeni’s 2% call hasn’t quite panned out with 2 weeks left in December, one could argue that Q1 2022 could see 2% on the 10-year potentially.
Either way, there seems to be no doubt that rates are going to have to rise relatively soon thanks to inflationary pressures.
“If you study the history of inflation in the U.S., whenever CPI surpasses 5.0% outside of wartime, the only thing that prevents inflation from marching higher is a banking crisis (’92, ’08) or significantly higher interest rates, which occur with a considerable lag,” trader Rosemont Seneca told me last week.
Read my full interview with Rosemont Seneca here: Only A Banking Crisis Or Higher Rates Can Stop Inflation Now: Trader
“Capital market participants today are of the consensual view that the Fed is hamstrung from raising their Target Rate significantly higher due to Treasury’s debt service and interest burden. We don’t buy that premise; if CPI inflation trends 10% or higher they will have to act with Volckerian resolution.”
I agree with Rosemont and think that there will be a pile on once bond traders get the cue that the Fed is out of the way and they can “leave the starting gate” in selling bonds.
To me, the only question is whether the ‘vigilantes’ will be there from the get-go or will simply ride the wave lower once it begins.
I’d love to hear your thoughts in the comments. Do you think bond vigilantes are dead? Leave a comment
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Sun, 12/12/2021 – 12:30