When governments borrow at unsustainable rates, it’s sometimes not the new faces in Congress that force a return to fiscal discipline, but the vigilantes of the bond market. Investment banks, hedge funds, insurance companies and other large investors will raise the government’s borrowing costs by selling off their holdings of U.S. Treasury securities, thereby raising the interest rates the federal government must pay to service its debt.
Ed Yardeni is an economist who spent decades on Wall Street at companies including Deutsche Bank and Prudential and now runs his own financial consulting firm, Yardeni Research. Yardeni Research). He coined the term “bond vigilantes” in 1983 to describe these investors who influence the market.
In a July 1983 paper titled “Bond Investors Are the Economy’s Bond Vigilantes,” he explained: “If fiscal and monetary authorities do not regulate the economy, bond investors will.”
Now, with the U.S. national debt and deficit at all-time highs, Yardeni thinks the bond vigilantes are out again. They have a new leader – billionaire hedge funder Bill Ackman.
“Barron’s announced today that Ackman is the new Bond King. We believe he is actually the Bond Vigilante King,” Yardeni said in a note to clients on Monday.
Ackman’s “Brilliant Deal”
In early August, Ackman, who runs Pershing Square Capital Management, very publicly shorted the 30-year Treasury note. He argued that rising federal deficits and gridlock in Washington, along with “structural changes” in the global economy – including deglobalization, the green energy transition and increased bargaining power of workers – will lead to higher inflation and fiscal instability. era. Inflation and fiscal instability mean investors should demand more compensation — in the form of higher yields — for the increased risk of holding U.S. Treasuries.
To Ackerman’s point, from Ministry of Finance It shows that in the 2023 fiscal year ending on September 30, the national deficit increased by nearly 25% year-on-year to $1.7 trillion. Increased spending has increased the national debt by more than $10 trillion over the past decade—from $22 trillion in 2013 to $10 trillion.Far beyond $33 trillion today.
Things weren’t that bad when interest rates were low, but now that bond vigilantes are out and the Fed is raising rates sharply to combat inflation, the cost of deficits is becoming prohibitive.Treasury interest expense surge It has grown 67% since the outbreak, from $544 billion per quarter in early 2020 to $909 billion per quarter this summer.
Ackman first disclosed his large bond short position on August 2 postal The news emerged on X (formerly Twitter) just one day after Fitch Ratings downgraded the U.S. Treasury credit rating from AAA to AA+. Between August 2 and October 23, when Ackman revealed he was exiting short positions due to an economic “slowdown” and geopolitical risks, the 30-year bond yield surged from 4.11% to over 5%.
When bond yields rise, bond prices fall—so this is a sign that his trade is profitable. “It was an outstanding trade,” Yardeni said of Ackman’s big short.
While it’s difficult to fully measure the impact of bond vigilantes on Treasury yields, the Fed does track the impact of so-called “bond vigilantes” on Treasury yields.regular premium“For the 10-year Treasury bond. The term premium measures the “extra” yield required by investors to hold long-term Treasury bonds rather than short-term notes or bills. When interest rates remained low in the mid-2010s, the required premium had been negative for years but has risen in recent years, suggesting the vigilantes may finally be awakening again. Since the COVID-19 lows, the term premium has surged from -0.9% to over 0.37%.
Ackman and other big investors may be pushing for more fiscal responsibility by shorting U.S. Treasuries, but it’s a dangerous time to be a bond vigilante. If the economy begins to struggle or the long-predicted recession returns, that could lead to the Fed cutting interest rates. This will cause long-term Treasury yields to fall, which in turn will cause long-term bond prices to rise. This is not good news for the vigilantes who are shorting these Treasuries, and this danger may temporarily stop them from running rampant.
When Ackman exited shorting Treasuries on Monday, he argued that geopolitical tensions between Israel and Hamas and the Russia-Ukraine conflict, as well as data showing an economic slowdown, posed significant risks to his short bond position.
“We agree with Ackerman,” Yardeni wrote. “There are too many immediate dangers in the current geopolitical environment. For now, this favors risk-off trades rather than risk-on trades.”
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