Bond Vigilantes

For you kids out there who may be too young to remember ancient American history, please allow me a moment to turn back to the days when Arkansan Bill Clinton was president. It was toward the end of the last century when he asked, “You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of f***ing bond traders?”

Greenspan headed the Fed then, but he was not to blame for Bill’s angst. Robert Rubin, then Treasury Secretary, was helping design these programs by inaugurating expensive spending plans.  The bond markets reacted to the perceived increase in government debt by selling some of their holdings.  As you no doubt are aware, such selling simultaneously drives up interest rates.  A decade prior, the economist Ed Yardeni coined a term for these bond traders: Bond Vigilantes.

Today’s head of the Fed, Kevin Warsh, announced this July that the Board chose to leave rates unchanged in an effort to allow bond markets to react as seen fit without any hints of policy decisions that might influence trading.  A clever move, I’d say.  Essentially, he told bond traders to vote in part on deficit spending, thereby providing a clearer view of opinions regarding current spending policies.  He released the hounds and as he was speaking, interest rates began rising, presumably indicating at least some concern about deficit spending.  The bond vigilantes seemed primed to come roaring back.  We’ll see; it’s still early days.

The next question might be: How will the current administration react to increased spending, growing budget deficits and higher interest rate costs on the money our economy must pay to continue borrowing?  Back then, Bill saw the handwriting on the wall and quickly reversed course.  The record shows our government’s deficit improved for the following four years, he did get reelected, and the U.S. actually enjoyed a surplus during his second term.  That favorable outcome has not been repeated since. One of Clinton’s political advisors, James Carville, when musing about reincarnation, declared he wanted “to come back as the bond market.  You can intimidate everybody.”  Will it be enough?