Bond Market Vigilantes
This is from the blog Political Irony (hat tip UMKC).
Higher consumer price inflation than we see now will probably result in demand destruction and recession before the Fed reacts. The slack in the economy would mean this becomes a deflationary force very quickly via plummeting asset prices. So I just don’t see enough interest rate pressure for rates going higher here.
Here’s what I have said about bond market vigilantes in the past:
- The Federal Reserve’s Quantitative Easing is Raising Inflation Expectations: Bond vigilantes can sell Treasuries in expectation of future rate hikes. (Remember, long rates are simply a chain of expected future short rates.) However, if the Fed remains on easy street for an extended period, what I call permanent zero, then eventually the vigilantes are going to have to say uncle. This is the tug of war now going on. You have serious asset and commodity price inflation that has begun to feed through into consumer price inflation – first in food and soon across the board. Central bankers like Ben Bernanke and Mervyn King are telling us this will pass. If it doesn’t, then they will be forced to either hike rates or accept stagflation. The bond market vigilantes are selling bonds in expectation that the central banks will hike. Who wins this battle?
- Kyle Bass on Japanese Insolvency and Systemic Risk in the Global Economy: Often the bond vigilante talk ignores the reality that the Fed can manipulate rates. The Fed could, if it wanted, decide to offer unlimited liquidity for a specific price (interest rate) somewhere on the curve as it does for Fed Funds. Moreover, longer term bond yields are only market representations of future short term yields. The bottom line is that if interest rates do move too far up, the Fed will work to bring them down; that much is assured. And because the Fed has unlimited liquidity at its disposal (because it can print money), there is no reason to believe it won’t achieve its objective if it wants to. Bond vigilantes can only go so far.
- Bill Gross: Deficit Hawk, Bond Vigilante: I think notions of the bond market vigilantes get the economics wrong. What bond market vigilantism usually implies is rising inflation, currency depreciation and/or lower long-term economic growth. Think of Great Britain post-World War II with its massive national debt load, for example.
- Market discipline for fiscal imprudence and the term structure of interest rates: Unless the U.S. economy starts operating at full capacity, consumer price inflation isn’t going to create interest rate pressure for the Fed. A central bank issuing debt in its own currency controls short-term rates. So, absent inflationary pressure when there isn’t significant slack in the economy, rates remain low. I think this is significant when thinking about bond market vigilantes and the like. But the key takeaway from the Japanese experience is the one I just outlined: sovereign central banks control short-term rates in the currency they issue and through the term structure, they also have some control over longer-term rates. When there is slack in the economy, there is only so far the bond market vigilantes can go. I’m not saying rates can’t rise. I’m saying that that rise is capped if an economy is in a balance sheet recession.
- Beijing is not Washington’s banker: The only question for China is which U.S. dollar assets it will buy, not whether it will go on a U.S. dollar strike. Of course, the Chinese could revalue as the Obama Administration is pressuring them to do. However, if the Chinese did significantly revalue their currency and pegged it at a higher rate, that sucking noise you would hear would be jobs leaving the overcapacity-riddled Chinese domestic economy. The China-as-Washington’s-banker stuff does make for good laughs on Saturday Night Live. But, it is bogus economics. The next time you hear these arguments you will know why
- Barack Obama: “if we keep on adding to the debt… that could actually lead to a double-dip”: If the U.S. private sector is increasing its savings, there is automatically a greater domestic bid for U.S. treasury securities. So, it is a misnomer to say the U.S. is dependent on foreigners, thinking that this must continue. If the private sector saves more, a larger percentage of government bonds will be bought with domestic savings. In Japan, interest rates did not spike when the government increased deficit spending for this very reason.
With the U.S. running trillion-dollar deficits, real yields at the short end below zero, and U.S. 10-year rates well below 4%, I ask where these so-called bond market vigilantes are. If they are supposed to be vigilantes, they aren’t very vigilant.