The Bond Vigilantes Are Back, Overriding The Fed’s ‘Go Slow’ Policy

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Inflation is galloping, real yields are tanking and Federal Reserve heels are dragging. Wall Street’s bond professionals have seen enough. The lack of reality and common sense has ignited the bond vigilante takeover of interest rates. And that means inflation’s effect on the financial markets is picking up speed, making Fed actions irrelevant.

Note: “Bond vigilantes” is a term from the past when financial and inflationary conditions were similarly messy, and Wall Street’s bond professionals reinstated order. (From Wikipedia: “A bond vigilante is a bond market investor who protests against monetary or fiscal policies considered inflationary by selling bonds, thus increasing yields.”)

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Here’s an example of what’s happening. The 10-year US Treasury yield is close to the 3% high reached previously during Fed Chair Powell’s slow march to “neutral.” At that time the federal funds rate was over 2%. Today, even after the Fed’s recent rise, it is a paltry 0.3%.

Why have the bond vigilantes returned now?

Four forces are driving Wall Street’s move away from the Fed’s desires.

inflation, The Fed’s great misread of “temporary,” then “transitory,” damaged the Fed’s authority as inflation took off, with no sign of slowing.

Negative real yields, The Fed’s lengthy experiment with negative real yields has ended with the inflationary jump and the Fed’s inability to adjust. Those huge negatives are simply unacceptable to investors.

money supply growth, Although the Fed teases about slowing down bond purchases (by creating new demand deposits), the huge Covid jump is still swirling about.

US Government deficit-driven debts, The notion of “necessary and good works” spending is overwhelming sound financial management, further powering the inflation engine. US government debt is now at a high 125% of annual GDP. The Fed’s UST bond buying has aided this outsized fiscal spending, basically turning the debt into new money supply (now almost $6 trillion).

The bottom line – Expect investors to react further

Nothing says “Do something!” like sudden, serious declines in prices – be they bonds, stocks or real estate. Bonds are there now, as are stocks. (See “Stock Market Drops Confirm End Of Line For Bullishness”)

Real estate? Cash investors are pouring into the housing market, driving prices higher, so far undeterred by the mortgage rate jump from 3.5% to 5%. However, just because they have plentiful cash now and prices are still rising doesn’t mean reality won’t bite later.

Holding cash reserves remains a good strategy. Better opportunities will occur when investor moods and media headlines are broadly negative.


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