Bond vigilantes. Who they are, what they want, and how you'll know they're coming

Summary

Podcast Summary: "Bond Vigilantes. Who They Are, What They Want, and How You'll Know They're Coming"
The Indicator from Planet Money
Release Date: November 21, 2024
Host: Waylon Wong and Paddy Hirsch

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Introduction to Bond Vigilantes

In the November 21, 2024 episode of The Indicator from Planet Money, hosts Waylon Wong and Paddy Hirsch delve into the intriguing concept of bond vigilantes—a term that has resurfaced prominently in recent financial dialogues. The hosts set the stage by highlighting the dual perception of bond vigilantes as either heroes or villains, depending on one's political and economic perspective. They emphasize the potent influence these investors wield over government fiscal policies and inflation control.

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Origin and Definition of Bond Vigilantes

Ed Yardeni, President of Yardeni Research and the originator of the term "bond vigilantes," provides a foundational understanding of these influential market players. Reflecting on the 1980s, Yardeni explains:

"The bond vigilantes will take law and order into their own hands if they don't believe that the government's fiscal and monetary policies are doing the job." [02:25]

Originally emerging as a reaction to the rampant inflation of the 1970s, bond vigilantes comprised major investors such as pension funds and heavyweight investment firms. Concerned about excessive government borrowing and economic overheating, they aimed to restrain fiscal excesses that could reignite inflationary pressures.

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Mechanics of Influence: Buying and Selling Bonds

Waylon Wong and Paddy Hirsch employ a Wild West analogy to elucidate how bond vigilantes operate within the financial system:

"The bond vigilantes were and are armed with two weapons, a pair of six guns, if you will, holstered on their right hip, bond purchases. And on the left, bond sales." [03:28]

Bond Purchases: When bond vigilantes withdraw their demand for government bonds—referred to as "pistols refusing to buy"—it forces the government to offer higher interest rates to attract buyers. This increase in yields makes borrowing more expensive for the government.

Bond Sales: Conversely, large-scale sales of existing bonds by these investors drive bond prices down and yields up, compelling the government to issue new bonds at even higher interest rates.

Waylon Wong succinctly captures the net effect:

"Both of The Bond Vigilante 6 guns have the net effect of costing the government more money. A lot more money." [05:09]

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Current Context: The Resurgence of Bond Vigilantes

With the national debt soaring to approximately $35 trillion, the stage is set for bond vigilantes to make a significant comeback. Marilyn Cohen, CEO of Envision Capital Management, discusses the current political climate's impact:

"If, under the Trump administration, spending continues with abandonment, then the bond vigilantes will say, okay, guys, get on your horses. We've got to take this into our own hands." [06:12]

The administration's proposed tax cuts and tariffs are likely to exacerbate the fiscal deficit, necessitating increased borrowing. This scenario heightens the risk of triggering bond vigilante actions, especially if the government's borrowing becomes perceived as unsustainable.

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Indicators of Bond Vigilante Activity

Recognizing when bond vigilantes are mobilizing is crucial for policymakers and investors alike. Marilyn Cohen outlines clear warning signs:

"You'll know the bond vigilantes are alive and well when you have one, maybe two treasury auctions in which the auction has a stutter step. Look at the front page of the Wall Street Journal when it talks about the treasury auction. Listen to the news snippets on the financial stations saying, oh boy, had an auction today and it didn't go well." [08:22]

A "stutter step" in treasury auctions—indicative of weak demand—signals that bond vigilantes might be exerting pressure on the government to adjust its fiscal strategies.

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Expert Insights and Future Outlook

While bond vigilantes hold significant sway, Ed Yardeni remains cautiously optimistic:

"Inflation's come down. Productivity looks like it's making a comeback. So it's conceivable that we won't even have a debt crisis, that maybe the Trump administration will succeed in at least stopping the debt to GDP ratio from going up. And that would be a big plus. And the bond market, I think, could live with that." [07:35]

However, with ambitious tax cuts on the horizon, the risk of increased borrowing persists. If coupled with economic slowdowns or stimulus measures, the likelihood of bond vigilantes taking decisive action grows.

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Conclusion: Navigating the Bond Vigilante Landscape

The episode concludes with a blend of humor and seriousness, emphasizing the importance of vigilance in monitoring fiscal policies and bond market indicators. Hosts Wong and Hirsch encourage listeners to stay informed, as the actions of bond vigilantes could have profound implications for the economy and individual financial interests.

As Ed Yardeni aptly summarizes the dynamic:

"The more a borrower borrows, the more the lenders become influential on the borrower." [07:18]

In an era of unprecedented debt accumulation, understanding the role and influence of bond vigilantes becomes essential for navigating future economic terrains.

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Notable Quotes:

• Ed Yardeni: "The bond vigilantes will take law and order into their own hands if they don't believe that the government's fiscal and monetary policies are doing the job." [02:25]

• Marilyn Cohen: "You'll know the bond vigilantes are alive and well when you have one, maybe two treasury auctions in which the auction has a stutter step." [08:22]

• Ed Yardeni: "Inflation's come down. Productivity looks like it's making a comeback. So it's conceivable that we won't even have a debt crisis..." [07:35]

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This comprehensive exploration by The Indicator offers valuable insights into the influential world of bond vigilantes, providing listeners with the knowledge to anticipate and interpret their potential impact on the economy and government policies.

Transcript

[Waylon Wong]

Npr. This is the indicator from Planet Money. I'm Waylon Wong.

[Paddy Hirsch]

And I'm Paddy Hirsch. If you've been paying any attention to the financial news this last week, and who hasn't, then you might have gotten wind of a new posse that's just ridden into town. Some say they're heroes, some say they're villains. Their name the bond Vigilantes.

[Waylon Wong]

Snappy. They're a blast from the past who are striking fear into the hearts of fat cat spendthrift politicians on both sides of the political divide. They're also, like most of us, big opponents of the hottest topic in the presidential inflation.

[Paddy Hirsch]

So on today's show, the bond vigilantes where they came from, what they want, and maybe most important, how you can tell when they're about to ride into action and do what they think needs to be done.

[Waylon Wong]

I get tied to the railroad tracks after the break.

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[Waylon Wong]

For as long as there's been government, there have been groups of people unhappy about the way that administrations do business. Lobbyists, interest groups, crowds in the street.

[Paddy Hirsch]

Yeah, some of these groups have more leverage than others, but none has as much leverage as the bond vigilantes.

[Ed Yardeni]

The bond vigilantes will take law and order into their own hands if they don't believe that the government's fiscal and monetary policies are doing the job.

[Paddy Hirsch]

This is Ed Yardeni. He's the president of Yardeni Research, an investment research firm and he's been investing and watching Wall street since 1978. You are the creator or the originator of this phrase bond vigilante.

[Ed Yardeni]

Well, that's guilty as Charged.

[Waylon Wong]

Oh, he was the first one to make a wanted poster that said bond vigilantes.

[Paddy Hirsch]

Oh, I didn't even think like that. But yes, absolutely right.

[Waylon Wong]

Ed came up with this phrase, bond vigilantes, to describe a group of big investors, think your pension funds and heavyweight investment firms who had been battered by inflation in the 70s. They were worried that the government's fiscal and monetary policies in the 80s could trigger more inflation.

[Paddy Hirsch]

Yeah. So they kind of formed this unofficial posse to force the government's hand, you know, to keep it from borrowing too much, from juicing the economy too much. All of which, of course, could fuel inflation.

[Ed Yardeni]

There were three episodes in the 1980s where bond yields rose, GDP growth slowed, inflation came down, and all was well.

[Paddy Hirsch]

Now, I understand that that might sound a little wonky. So allow me to extend this wild west analogy to explain what this posse of debt hating investors actually did. The bond vigilant were and are armed with two weapons, a pair of six guns, if you will, holstered on their right hip, bond purchases. And on the left, bond sales.

[Waylon Wong]

And we are talking about government bonds here, US treasuries, and particularly longer term treasuries like 10 year notes and 30 year bonds, which, as all loyal indicator listeners know, are sold by the treasury at auctions throughout the year.

[Paddy Hirsch]

Yeah. And the treasury, when it sells these bonds, counts on a lot of buyers showing up. The more buyers, the more demand and therefore the less interest the treasury ends up having to pay.

[Waylon Wong]

But what if those buyers, especially those big buyers like pensions, endowments, and investment shops like Vanguard and Fidelity, what if they decide not to show up?

[Paddy Hirsch]

Aha. And this is the first of the bond vigilantes. Pistols refusing to buy.

[Ed Yardeni]

Not enough people show up for the treasury auction. And it's a sloppy auction.

[Waylon Wong]

Tumbleweeds at the bond auction, Patty.

[Paddy Hirsch]

Tumbleweeds at the bond auction.

[Waylon Wong]

Yeah.

[Paddy Hirsch]

If there's not enough demand for government bonds, the treasury has to increase interest rates or yield yields to get people to buy them, which, as Ed says, can get very expensive.

[Waylon Wong]

The second weapon is bond sales. These investors hold a lot of bonds, billions upon billions worth. What happens when they get nervous about the way the government is handling inflation?

[Ed Yardeni]

People who actually own these things just willy nilly call their broker today and say, just get me out of these bonds. I don't want to take any risk. I want to see how things play out.

[Paddy Hirsch]

The vigilantes sell their bonds, prices fall, yields, of course, rise. And now the government is forced to issue any new bonds at a higher interest rate.

[Waylon Wong]

Both of The Bond Vigilante 6 guns have the net effect of costing the government more money. A lot more money. No wonder the bond vigilantes have so much power. But we've been racking up debts for years now. So why have the bond vigilantes decided that now is the time to make a comeback?

[Marilyn Cohen]

Now you've got a new administration in. They want to get certain things done, but I don't hear the words cut the spending.

[Paddy Hirsch]

This is Marilyn Cohen, the CEO of Envision Capital Management, an investment firm. She's been investing in bonds since 1979. Almost as long as Ed Yardeni. She says the way she sees it, the bond vigilante posse has drawn up on the outskirts of town. They're holed up in a cantina, drinking whiskey and waiting to see how things go down in the new year.

[Marilyn Cohen]

If, under the Trump administration, spending continues with abandonment, then the bond vigilantes will say, okay, guys, get on your horses. We've got to take this into our own hands.

[Paddy Hirsch]

Are you a bond vigilante, Marilyn?

[Marilyn Cohen]

I would not. Well, no. It takes an institution far larger than envisioned capital is. It takes the pimcos, it takes the blackrocks, it takes the treasures of pension funds to just say, we're on strike. We are not buying any of these. And it can have an effect if they all do it in concert.

[Paddy Hirsch]

Would you like to be a bond vigilante?

[Marilyn Cohen]

No, I'd love to. I would love to. It would make me feel so powerful.

[Waylon Wong]

She is saddled up. She's ready to go. Just waiting for that phone call. Well, with the national debt standing at roughly $35 trillion, bondholders should feel powerful. They have a lot of potential influence, maybe too much influence. Ed Yardeni says that's the government's fault for not keeping a grip on spending.

[Ed Yardeni]

This is what happens when borrowers borrow a lot of money and become dependent on their lenders. The more a borrower borrows, the more the lenders become influential on the borrower.

[Paddy Hirsch]

Yeah, and the US has been borrowing a lot more lately. Still, Ed says things are looking up.

[Ed Yardeni]

Inflation's come down. Productivity looks like it's making a comeback. So it's conceivable that we won't even have a debt crisis, that maybe the Trump administration will succeed in at least stopping the debt to GDP ratio from going up. And that would be a big plus. And the bond market, I think, could live with that.

[Waylon Wong]

Fingers crossed. But Trump has talked about some big tax cuts. They won't be cheap. Ed says they will likely have to be paid for with new borrowing and the tariffs Trump has talked about could also cut into tax revenues. That would force the government to raise money by going back to the bond market.

[Paddy Hirsch]

Yeah, and if the government does end up having to borrow more, or if the economy begins to stall and the government decides to juice it with stimulus, those bond vigilantes could decide to saddle up. But Marilyn Cohen says we'll get plenty of warning if they do.

[Marilyn Cohen]

You'll know the bond vigilantes are alive and well when you have one, maybe two treasury auctions in which the auction has a stutter step. Look at the front page of the Wall Street Journal when it talks about the treasury auction. Listen to the news snippets on the financial stations saying, oh boy, had an auction today and it didn't go well. You know, that's the stutter step and I think that will be very important.

[Paddy Hirsch]

In other words, keep listening to this show. We'll let you know if the bond vigilantes are riding. This way you can decide whether to stay in town and tough it out or run for the hills.

[Waylon Wong]

I would run, but I'm still tied up to this railroad track.

[Paddy Hirsch]

Patty the Trains are Coming.

[Waylon Wong]

This episode was produced by Julia Richie with engineering by Valentino Rodriguez Sanchez. It was fact checked by Sierra Juarez. K. Ken Cannon edits the show and the indicator is a production of npr.

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