The Bond Vigilantes Strike

 Most market commentators attributed last week’s bond market sell-off to the lack of specificity in newly installed Fed Chair Kevin Warsh comments during his post-open market committee news conference. Although the Fed voted to keep the Fed’s target rate unchanged, regional bank presidents Beth Hammack, Lori Logan and Neil Kashkari voted for an increase thereby issuing a challenge to Warsh who has said that “inflation is a policy choice.” Warsh did not give any guidance as to how the Fed will bring inflation down to its long missed 2% inflation target. Thus, short-term interest rates declined as long-term interest rates rose in a classic bear steepener trade.

 

To be sure, I am in general agreement with Warsh on the limitations of forward guidance. The markets should not be spoon-fed the Fed’s outlook as to the course of short-term interest rates. As I noted a decade ago, the Fed should not be the stock market’s fairy godmother. (See:https://shulmaven.blogspot.com/2016/01/memo-to-stock-market-janet-yellen-is.html )

 

My sense is that the back-up in yields has more to do with the return of the late 20^th century bond vigilantes in a 21^st century form. Simply put, the back up in the 30-year Treasury yield to 5.27%, its highest in 17 years and new multi-year highs in British, French, German and Japanese yields is telling us that something more fundamental is going on than a Fed meeting. What the markets are coming to grips with is the fiscal train wreck across the industrialized world, combined with supply shocks and an unprecedented amount of business investment associated with AI. Put bluntly, there is not enough funding to go around and the bond vigilantes sense this. There are more uses of funds than sources of funds.

 

In my year-end outlook I noted that the 30-year Treasury Bond would end this year at around 5.5%. (See: Shulmaven: 2026: A Year of Turbulence ) My guess is that target is likely to be exceeded before year-end and that it will likely have a 6 handle on it next year. Although the stock market rallied late week in response Citadel’s covering the hedge fund Situational Awareness’ margin call, it will soon turn its focus to the bearish forces emanating from the bond market.