"What Role for the Bond Vigilantes?"

From Project Syndicate, March 7: 

J. Bradford DeLong , Brigitte Granville, Desmond Lachman, Paola Subacchi, and Edward Yardeni

Higher interest rates and growing government debts and deficits have led many financial commentators to wonder if policymakers in major economies should be more worried about the bond markets - a famously exacting source of discipline when all else fails. Are they on to something?

PS Quarterly regularly features predictions by experts on topics of global concern, and as we move further into 2025, the macroeconomic outlook has moved to the top of the list. Following the long era of low interest rates during the 2010s, the return of inflation and higher sovereign bond yields since the pandemic has led many in the financial press to proclaim that the “bond vigilantes are back.”

Coined by the investment strategist Edward Yardeni in the 1980s, the term captures sovereign-debt investors’ role of constraining the scope of economic policymaking. While traditionally associated with chronically troubled economies like Argentina, the bond-vigilante effect is increasingly factoring into analyses of major advanced economies such as the United States, too. Nor is this development confined to speculation by pundits. “If you’re seeking clues about the potential for bond vigilantism, you might start by asking the largest fixed income investors – who theoretically hold the most market sway – what they’re doing,” write two strategists at PIMCO, which is “already making incremental adjustments in response to rising US deficits.” To assess whether this sentiment represents a new normal, we asked contributors if they agree or disagree with the following proposition: “Bond vigilantes” will become a persistent issue for major economies.

Edward Yardeni 

Almost every time that bond yields jump higher just about anywhere in the world, I get at least one reporter calling me asking if the bond vigilantes are behind the move. I coined the term back in the July 27, 1983, issue of my weekly commentary, under the headline “Bond Investors Are the Economy’s Bond Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”

Of course, bond investors are not thinking about regulating the economy. They are simply acting in their perceived financial best interest – that is, out of increasing or decreasing concern that inflation might erode the effective purchasing power of their returns. A related concern is that deficit-financed fiscal policy is excessively stimulative, which increases the risk of inflation and adds further to the debt. Excessively stimulative monetary policy is especially alarming if it is enabling the profligacy of fiscal policy.The bond vigilantes did play an important role in regulating the business cycle during the 1980s. They were less important during the 1990s, because US President Bill Clinton was warned by his economic advisers to maintain fiscal discipline or face their wrath. Now, it seems that US Treasury Secretary Scott Bessent is trying to convince his boss, President Donald Trump, that the bond market is more important than the US Federal Reserve.The bond vigilantes are biding their time, waiting to see how the Trump administration will slow the increase in spending as a result of the Department of Government Efficiency’s efforts. If they don’t deliver enough spending cuts, there could be a gunfight at DOGE city, with the bond vigilantes shooting holes in Trump’s fiscal agenda, including his promised extension of the 2017 tax cuts.

Brigitte Granville 

I disagree with the proposition. Even smaller countries’ greater vulnerability to bond vigilantes will be occasional, rather than persistent. Nonetheless, such vigilantism – understood as financial markets constraining governments’ choices – could prove effective not through bonds but rather equity markets....

....MUCH MORE