Who are the Bond Market Vigilantes?

I’ve noticed “Bond Vigilantes” being mentioned in both headlines and various newsletters over the past few weeks. The graph above shows the number of times that the term is being searched in Google from 2009 to present. It’s important to understand the history of the term and why it matters now.

Economist Ed Yardeni coined ‘Bond Vigilantes’ in 1983. He used the term to refer to bond market traders who would punish countries by selling their bonds, thus driving up interest rates, if they became worried about nations’ inflation rates, deficits or debts.

I first became acquainted with the term in 1995. I had started as a commodity broker at CA Global Futures AG in Vienna, Austria. We operated a small ‘up desk’ in the very heart of the city, with clients from Austrian banks to the Slovakian national oil company. My responsibilities were primarily in physical commodities (LME copper and aluminum, and IPE & NYMEX crude oil and products) though because we were a small desk, we all were familiar with and brokered nearly every futures contract imaginable—Azuki beans in Japan; Bunds on the DTB and LIFFE; London and New York coffee; and Kansas City, Minneapolis, Chicago, and Paris wheat.

In late 1993, and throughout 1994, interest rates rose for nearly every country around the world. After the collapse of the British Pound and its ejection from the European Monetary System, financial markets had become very skeptical of the ability of nations to operate their finances in preparation for the Euro. Specifically, they were worried that increasing debts and deficits would make European monetary integration impossible. At first, those worries were directed at more profligate nations, but in time those worries spilled over everywhere, including the US and Japan.

The rate increases were sharp, in the US, 10 year interest rates went from 5.36% to 7.96% in 14 months. In Japan, rates climbed from 3.4% to 4.8% in eight months. After the markets of 2020-2023, these changes might not seem so severe, but a key difference is that there were no meaningful changes in these economies leading up to the so-called Great Bond Massacre of 1994. There was no pandemic or rapidly accelerating inflation. There was no rapid acceleration of deficits or debt; the market simply changed its mind about how much it wanted compensated for the risks it was bearing.

Globally, nations moved quickly toward fiscal austerity. Europe went into recession in 1995 and 1996, depending on the country. Why? Because the Bond Market vigilantes changed their minds one morning in late 1993.

I am often asked about the debt, and whether it matters. I like to quote Dick Cheney in 2003, who said, “Reagan proved that deficits don’t matter.” I like to append “until they do” to Cheney’s quip.

If we look at the debt-to-GDP of these same countries, the first thing to notice is that there really isn’t an obvious reason for the Vigilantes to have intervened when they did in 1994, especially when we look at debt levels today. While Italy’s debt level is similar to its level in the early 1990s, Japan’s has tripled, and US and UK levels have doubled, yet we haven’t seen that same sort of spike. At least not yet.

But grumblings are growing on Wall Street. In the 2024 election, neither candidate paid even lip service to fiscal rectitude. Both promised many and varied cuts in taxes and increases in spending. Both seem to buy more into Dick Cheney’s take than mine. History doesn’t look kindly on this silence, and neither do the bond markets. Based on the moves in the past few weeks, I expect to see a continued steepening of the yield curve. The Fed has cut rates again by 0.25% today and I think they are done until they get stronger signals of a slowing economy. The real risk is bond market downside—as worries about growing deficits and debts, and potentially more worries about a resurgence of inflation in response to tariffs and immigration policy.

If you have exposure to longer interest rates, whether through bond investments or borrowing, the risk is moving toward bonds and away from equities. When will it start happening? When the wind shifts, the moon is right, and attitudes change. Maybe in a week, maybe in a year, but the current path risks awakening those vigilantes once again.