On a short leash: How "bond vigilantes" impose their will on politicians

The year 2025 could be one of the busiest years for bond vigilantes in decades - since the beginning of the year, investors have already dictated their will to politicians in the US, UK and Japan several times. Have these "guardians" of the market become stronger, or do they have more reasons to fear?

"I used to think that if reincarnation existed, I'd want to be reborn as president, pope, or a baseball player with a .400 batting average (terminus means that a player strikes out 40% of the time, a very high score - ed). But now I want to reincarnate in the bond market: you can intimidate anyone." These words of James Carville, Bill Clinton's political adviser, said more than 30 years ago, take on special relevance this year;

It was the turbulence in the U.S. bond market in April that forced President Donald Trump to postpone import duty hikes for dozens of countries. Recently in the U.K., Prime Minister Keir Starmer was forced to issue statements in support of the finance minister to curb a selloff in the pound and government bonds. And in 2022, investors effectively "fired" British Prime Minister Liz Truss: her cabinet's fiscal stimulus plan caused a crisis in the markets, and she had to leave;

Analysts and financial observers are once again talking about the return of "bond vigilantes." The term was coined in the 1980s by economist and investment strategist Ed Yardeni to describe investors who "vote with their feet" against the government's wasteful fiscal policies. Fearing rising government debt and accelerating inflation, investors sell bonds and stop buying new issues.

As a result, bonds become cheaper and their yields rise. This promises governments an increase in debt servicing costs. More expensive government borrowings can lead to higher interest rates for households and companies, which creates risks for economic and financial stability. Therefore, the authorities are often forced to listen to the "guardians" of the market and change their policies;

When the U.S. president announced his decision to impose giant import duties on dozens of trading partner countries on April 2, proclaiming the date as America's Emancipation Day, stocks reacted with a sharp decline. Trump is famous for his attention to the stock market: in the past, he has repeatedly cited rising stocks as evidence of the success of his policies. But he continued to push for higher rates for another week - until a massive sale in the bond market began.

Usually, U.S. government bonds, considered a protective asset, are in demand during stock market shocks. The fact that in April they were disposed of at the same time as stocks was perceived as a signal of investors' disbelief in the future financial stability of the United States. It was the U.S. Treasury Department's concerns about what was happening in the debt market that played a key role in Trump's decision to postpone most of the duties, sources told CNN.

The yield on the 10-year UST, which rose briefly above 4.5% during the selloff to its highest since February, is particularly important to the economy: it is a benchmark for rates on auto loans, mortgages and credit cards, as well as long-term business borrowing.  "This bond market is very tricky, I've been watching it," noted Trump himself, though the sudden "pause" in the rate war was presented as part of a negotiation tactic by the White House.

"The bond market scared the president," said Yardeni, who now heads his own consulting firm, Yardeni Research, in an interview with CNN. -  "The bond vigilantes" were screaming that they weren't happy with what was going on, and there was a threat of recession."

Debt market investors have repeatedly managed to "tame" politicians on the other side of the Atlantic. In September 2022 in the UK, the Truss government, formed a few weeks earlier, announced the biggest tax cut in half a century - by 45 billion pounds. The authorities believed that, together with a freeze on energy prices for households and businesses, it would spur economic growth;

However, investors decided otherwise and began dumping British assets: the pound fell to an all-time low against the dollar, and the yield on 10-year government bonds soared to its highest since 2008;

The government did not give a clear explanation on how exactly it plans to finance the tax cuts. Therefore, market participants feared a boom in borrowing and a budget deficit. Bonds were rattled so badly that the Bank of England was forced to intervene and start buying up long bonds in order to hold down yields and prevent the crisis from spreading to the real economy. As a result, the government abandoned most of the promised fiscal measures.

Finance Minister Kwasi Kwarteng lost his finance minister post in mid-October, and Truss herself resigned at the end of the month. Her 49-day term as prime minister was the shortest in Downing Street's history. 

More recently, the UK has again been on the radar of the "bond vigilantes". This time, however, they came out on the side of the finance minister. Investors began selling off bonds on July 2, after failing to hear a clear signal from Prime Minister Keir Starmer in support of Finance Minister Rachel Reeves;

Responding in Parliament to criticism from Conservatives, Labor's Starmer initially refrained from assuring Reeves would keep his post. Footage broadcast from the debate showed her brushing away tears. Reeves said later that her emotional reaction was due to personal circumstances, and Starmer was quick to state that she would remain chancellor of the Treasury "for many years." This somewhat allayed investor fears that the authorities' fiscal policy would become less prudent in the event of Reeves' resignation;

"Unless the British government takes decisive action to restore confidence in the markets, the rising slope of the government bond yield curve and the sell-off in the pound will continue in the style of the Truss situation," noted Luigi Buttiglione, founder of consultancy LB Macro. - This will inevitably force the government to capitulate, as was the case with Truss and even Trump after the infamous Emancipation Day. The market always wins."  

"Bond vigilantes" were not only seen in the West. Yields on 30-year bonds in Japan rose to a 25-year high on July 15 on fears that if the ruling coalition is defeated in elections, supporters of populist measures requiring additional government spending will come to power;

"The problem is that we can't completely rule out uprisings  'bonded vigilantes' like the shock with Trass," noted SMBC Nikko strategist Ataru Okumura.

The strengthening of the "bond vigilantes" position in recent years, according to Yardeni's opinion, is due to a sharp rise in government debt issuance. For example, the amount of U.S. Treasury securities circulating on the market by the end of June was $28.7 trillion, compared with less than $20 trillion before the pandemic and less than $5 trillion before the 2007-2008 global financial crisis. In an effort to revive economies paralyzed by Covid-19, governments around the world implemented fiscal stimulus, while increasing borrowing and driving up inflation. The global volume of government debt last year exceeded $100 trillion for the first time in history;

The rapid growth of the U.S. debt burden was also observed at the beginning of the last decade, but then investors had less opportunity to influence the quotations of Treasury securities. After the 2008 crisis, the Fed bought government bonds in volumes that dwarfed any sales by the private sector. That kept yields near historic lows. In the early 2020s, on the contrary, the regulator tightened monetary policy in an attempt to curb inflation, and this untied the hands of the "bond vigilantes";

But in the eurozone in the 2010s, they went on a rampage. First Ireland and Greece, and then other peripheral countries of the bloc found themselves in the midst of a debt crisis. Investors sold their bonds en masse, pushing yields to alarmingly high levels. As a result, governments that had previously allowed sovereign debt to rise to high levels had to tighten their belts and implement fiscal austerity policies to stabilize their fiscal positions and restore market confidence.

Special privileges....

"Beware of 'bond vigilantes' - all eyes are on budget deficits," the Institute of International Finance (IIF) warned in February, noting the particular vulnerability of countries with high levels of political polarization. In the U.S., however, sustained economic activity and the reputation of government debt as a protective asset continue to mask a growing decline in fiscal strength, the IIF noted, while, for example, the U.K. is deprived of such privileges;

That partly explains why investor concerns didn't prevent the passage of Trump's flagship tax cut bill, even though it is estimated to increase the budget deficit by at least $3.4 trillion over the next decade. Thanks to the dollar's status as a reserve currency, the US can afford more fiscal profligacy than most countries. The Treasury bond market simply has no peer yet in terms of size, liquidity and depth, noted Hugo Panizza of the Geneva Institute of International Affairs and Mitu Gulati of the University of Virginia.

For governments that, unlike the U.S., do not have the "exceptional privilege" of the dollar's role in the global economy, the sentiment of "bond vigilantes" is more important, suggests University of California at Berkeley professor Bradford DeLong: "The leash will remain short, and markets won't hesitate to pull it if you get off the beaten path."[ 

However, the U.S. doesn't have 100 percent protection against "bond vigilantes" either, especially if the Trump administration continues to pursue budget-busting policies that could undermine confidence in U.S. institutions and long-term economic growth. Treasury Department head Scott Bessent himself recognized that the government debt numbers look "frightening" and noted that it is "very difficult" to predict the tipping point at which investors will "revolt."

Several major investment firms in May said they were diversifying their bond portfolios in favor of non-U.S. assets and noted the attractiveness of European debt markets. Interestingly, the choice of some of them fell on the securities of Italy and Spain - countries that a decade and a half ago were themselves victims  of the "bond vigilantes" and resorted to fiscal austerity to stop the flight of investors.

Economists and portfolio managers agree that it is difficult to predict in advance when the "bond vigilantes" will become active again. But history shows that governments should be alert to signs of discontent in debt markets - otherwise both the financial stability of their countries and the political prospects of the authorities could be jeopardized.

This article was AI-translated and verified by a human editor