It’s time to talk about Bond Vigilantes.
How Does a Proper Bond Vigilantes Trade Work?
Contrary to popular belief, a true bond vigilantes trade doesn’t only require bond yields to go up. Bond yields can go up for a variety of reasons, including strong nominal growth.
For a true Bond Vigilantes trade, you need a combination of:
- Higher long-end bond yields
- Weaker currency
- Weaker equity markets
Basically, the gist of a Bond Vigilantes trade is this.
Bond market investors require fiscal discipline and coherent policies from policymakers.
To force policymakers to comply, they sell long bonds, hence injecting a risk premium in the markets.
This risk premium is then also reflected in a weaker currency and weaker equity markets: cross-asset investors start to require a premium to hold any assets for that specific country.
Financial conditions tighten across the board due to higher yields, a weaker currency, and weaker equity market,s and this negatively affects the economy.
A Vicious Doom-Loop Unfolds
And it’s only when policymakers comply to the requests of Bond Vigilantes with tighter fiscal policy, rate hikes or friendly policymaking that the pressure is relieved and we can go back to normal markets.
As you can see from the chart below, Bond Vigilantes in the US have rarely been at play for a prolonged period of time - the red box doesn’t contain many dots going back 50+ years.
Today we are dangerously flirting with such an environment: 30-year yields have shot up, the S&P 500 is suffering, and the US Dollar is going down.
Do you think we can have Bond Vigilantes show up in the US for real?