vigilantes…

Vigilantes were members of 19th century American “vigilance committees,” composed of citizens who banded together to render immediate, and often rough, justice in circumstances where they felt formal law enforcement actions were insufficient.  Whether this was a good thing or not, I don’t know.  But the idea of vigilantes has become part of American folklore.

…and bond vigilantes

I first saw the term “bond vigilantes” in the 1980s in the work of brokerage house economist Ed Yardeni.  My impression is that he invented it   …but, hey, I’m a stock guy not a bond expert.  The idea was that should the Fed falter, due to political pressure, in its mandate to contain inflation under Paul Volcker (as it had throughout the 1970s, under his predecessors), private bond investors would step into the Treasury market and tighten money policy (by pushing up bond yields) whether the Fed liked it or not.

The concept later morphed into the idea that private bond investors would routinely raise and lower bond prices, and thereby interest rates, in the way sound money policy would dictate.  The market would act in advance of formal Fed moves.  Fed actions wouldn’t normally break new ground, but would serve to validate the direction the market was already taking.  This supposedly took some political heat away from the Fed during the long and difficult road of containing the runaway inflation of the Seventies.

Like most generalizations from current experience, the bond vigilante idea worked for a while.  But it has long since lost its usefulness.  For one thing, China became a huge factor in the US bond market as it recycled its trade surpluses.  And Alan Greenspan gradually developed a penchant for smoothing every little bump in the economic road with another huge dollop of easy money.  Ironically, one of the “problems” he dealt with in this manner was the Y2K scare–popularized almost single-handedly by the same Ed Yardeni.

(If you recall, the thesis was that, due to a programming shortcut, every electronic device that contained a computer chip with a clock in it would stop working at the stroke of midnight on 12/12/1999.  That meant refrigerators, elevators, ATMs, PCs…everything.  Software of all types would go kablooey, as well.  So bank and medical records would likely disappear.  During 1999, survivalists were in their glory.  They stockpiled horse-drawn plows–inconveniencing the Amish considerably–and gold and silver coins.  Regular people stockpiled water and gasoline (because pumps might not work, either.

It’s hard to know–since none of the bad stuff happened–whether Yardeni was a hero for alerting the world in time to avert the worst, or just a little nuts.  But he certainly gave Greenspan an excuse for maintaining an easy money policy.)

why the trip down memory lane?

I think I saw the activity of bond vigilantes in trading during the first quarter of this year.  The 30-year yield moved up from 2.94% in December 2011 to 3.33% last week.  The 10-year yield went from 1.94% to 2.21% over the same span.  This, despite Ben Bernanke’s continual assertion that the Fed intends to keep interest rates low through this year and next.

Of course, yields have reversed themselves sharply in the current mini-panic over the latest Employment Situation report and the uptick in southern EU bond yields.  But I read this more as a ripple caused by short-term traders than anything else.

And why shouldn’t the bond vigilantes re-appear?  After all, Mr. Greenspan no longer has his hand on the money spigot.  And China is much less of a net buying force in Treasuries than in the past.

Significance?  We may be seeing the first steps in the normalization of interest rates–far in advance of when the Fed wishes.  Two implications, assuming the markets are correct:

–the US economy is in better shape than the consensus realizes, and

–a sharp divergence in performance between stocks and bonds–in favor of the former (previously, I’d made a typo here)–may be about to begin.