Bond vigilantes are back

The bond vigilantes are back, or put differently, the bond investors have left the building. The impact of the bond vigilantes is real as evidenced by the sharp decline in 30-year Treasuries in response to the Treasury auction. No one wanted to buy 30-year bonds at 4.37% even with the economy falling into recession. The large sell-off pushed yields up to 4.51%. This will send a signal to the government. The argument is not like the Clinton deficit issue of the 1990's but one of inflation and foreign buyers. If you are going to debase the currency with higher inflation, international investors are going to boycott.

Remember this old story. Former US Treasury secretary Robert Rubin convinced his boss, President Bill Clinton that taming the “bond vigilantes” by reducing the budget deficit was the surest way to reach long-term economic prosperity. As Clinton’s political guru James Carville famously put it, “I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter, but now I want to come back as the bond market. You can intimidate everybody,” he once quipped.

A good definition of bond vigilantes.

Richard Russell in Dow Theory Letters offers this viewpoint: "These are the bond people who are like bloodhounds when it comes to inflation. When the bond vigilantes smell even a hint of inflation, they head for the exits, meaning they unload their bonds."

The current 10-year yields are actually lower than the when we were in the last recession. Bond yield bottomed actually in June 2003, but all the buyers at that time are underwater and inflation is higher. There is little reason to hold US bonds when there are a number of countries that have higher current yields and have central banks which are still worried about inflation. The US economy is weak and the Fed is likely to do more cutting which may lead to further inflation pressure. We have moved from a bond market that was focused on growth and declining yields to one that is now focused on inflation.

The new battle will be between the bond vigilantes and the desires of the home borrower. Let the battle begin.