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

https://ift.tt/9PWlnDY


Bond vigilantes riding to the rescue

getty

Inflation is galloping, real (inflation-adjusted) 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 restored 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.”)

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%.

10-year UST yield (green line) on a new, independent rise from Federal Funds rate (red line)

John Tobey (FRB of St Louis – FRED)

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.

CPI inflation rate continues its high 1-1/4 year rate

John Tobey (StockCharts.com)

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.

Green area shows nominal 3-month UST interest rate. Red shows real (inflation-adjusted) rate

John Tobey (FRB of St Louis – FRED)

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.

The $5 T Covid money supply increase continues to build (green line). Although down from its extreme … [+] 25% annual rate, it is still at high 10% growth rate (red line)

John Tobey (FRB of St Louis – FRED)

U.S. 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).

Federal debt is at an overly high level of 125% (red line) and yet the $T deficit spending continues … [+] apace. The Federal Reserve’s multi-$T purchases (green line) kept bonds off the market, but produced new demand deposits (money supply)

John Tobey (FRB of St Louis – FRED)

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.

Cash reserves, awaiting investment, remains a good strategy. Better opportunities will occur when investor moods and media headlines are broadly negative.

Financial Services

Get In Touch