Yardeni: ‘Bond Vigilantes’ Not Dead Yet

December 02, 2020

Dr. Ed Yardeni is the president of Yardeni Research, a provider of global investment strategy and asset allocation analyses and recommendations. He previously served as chief investment strategist for several leading financial firms and was an economist with the Federal Reserve Bank of New York. In the 1980s, Yardeni coined the term “bond vigilantes,” which are investors who sell bonds in protest of monetary policies, driving up yields. With bond yields stuck below 1%, and a new presidential administration that has announced former Federal Reserve Chairwoman Janet Yellen as its Treasury Secretary nominee, ETF.com caught with Yardeni to talk about his thoughts on the bond market and what investors should be paying attention to.

(Ed Yardeni will be a featured speaker at “The World of ETF Investing Virtual Expo” Dec. 7-9. You can sign up for free here.)

ETF.com: “Bond vigilantes” in their heyday could move the bond market. We don’t hear about them much anymore. Are they dead?

Ed Yardeni: The bond vigilantes have been buried by the extremely powerful central banks. Since 2008, they have increasingly meddled in the fixed income markets. Of course, the Fed's always meddled in the money markets targeting the fed funds rate.

During World War II until the early '50s, the Fed kept interest rates close to zero in an agreement with the Treasury for the war effort. It wasn't until the early '50s that they were able to get out of that deal, and started to allow interest rates to rise along with inflation, and manage the short end of the yield curve through open market operations. But the bond market was fairly free to move rates based on supply and demand, and inflationary expectations.

Bond vigilantes first appeared on the scene in the '70s, when bond investors pushed the yields up too little too late relative to inflation. Bond investors got hosed as yields rose along with inflation. In the 1980s is when the bond vigilantes really came to the forefront. A few times they pushed bond yields up faster than inflation, and subsequently, nominal GDP growth slowed [higher rates slowed growth], and so did inflation. That was their heyday.

I guess you could say their prime occurred in the early '90s with Bill Clinton conceding that his fiscal policy had to take into account the wishes of the bond vigilantes and not get them too riled up for fear of having them push bond yields back up again.

ETF.com: Who are these vigilantes?

Yardeni: It can be anybody who owns bonds and sells them. It's individuals, it's institutions, it's Wall Street. There's no way to specifically identify them. The bond market's huge and there's no way that you can say that there's any one or group of people that you could identify as bond vigilantes. It's really more descriptive of how the market in the past responded to developments in the economy.

When the bond market seemed to sense that the Fed wasn't doing enough to keep a lid on inflation, that's when bond yields went up in the ’80s and early '90s. But some of that was really just an overreaction by the bond vigilantes to having been annihilated in their positions during the '70s.

They never forgot it; we constantly had people worrying about inflation making a comeback. And in many ways, inflation was a 1970s kind of phenomenon related to oil shocks and getting passed-through wages through cost-of-living adjustments.

The ’70s was a traumatic decade, and it comes back to traumatize us again on a regular basis.

But the reality is, there have been very powerful forces besides the bond vigilantes that have brought inflation down. As inflation has come down, the bond vigilantes felt less need to be vigilant, and along the way, the central banks came in following the financial crisis of 2008, and became much more aggressive in keeping the short end of the yield curve down close to zero, which obviously has an impact on the bond market.

But I would say that, since March 23, the Fed has unofficially been targeting the bond yield to be below 1%. That's the only explanation, because the [10-year Treasury] bond yield should be 1.5-2% right now based on all sorts of different indicators and yet it's below 1%.

I'm watching the Fed's balance sheet to see what they're buying, and they've been buying a lot of notes and bonds, more than the Treasury's been issuing. I think the Fed has actually done something that they did not do in the past, which is target the bond yield, at least unofficially.

They’ve talked about yield curve control, which would be an official announcement that they’ve pegged the bond level at some level. The Japanese have been doing that for quite some time to get the bond yield to zero. But the Fed hasn't officially announced that.

But actions speak louder than words, and what they're clearly doing, in my opinion, is keeping the bond yield below 1%.

ETF.com: We saw this run-up of the 1-year Treasury yield prior to the election. Was that some sort of bond vigilantism going on in reaction to perhaps a Biden administration?

Yardeni: No, I think it suggested that the bond vigilantes aren't completely dead. They're kind of like zombies—they've been buried, but they're still alive, and seemed to start acting up when we got to 90 basis points.

But look where we are now. Not a lot of change other than we're going to have vaccines, which would lead to even higher bond yields.

But I think the Fed just continues to be very aggressive in offsetting the forces that are pushing bond yields up. Every time the bond zombies stick their heads out of the grave, they seem to try to bury them deeper down. That's the only explanation I can come up with for watching what the bond market's doing.

ETF.com: President-elect Joe Biden will be nominating former Federal Reserve Chairwoman Janet Yellen as Treasury Secretary. What’s your thought on that?

Yardeni: In many ways, the Fed is more powerful than the Treasury, because the Fed can implement monetary policy much more easily than the Treasury can. The Treasury has to go through Congress, and it gets very political.

Yellen is one of the most experienced economic policymakers in Washington today. She's liberal, which fits in perfectly with the Biden administration. But she's not as left-wing as some of the left-wing extremists in the Democratic Party.

So, in many ways, she's perfect for the role. Biden clearly wanted to have somebody who knows where the keys are to all the doors at the Fed. And Yellen certainly is that person. And she's going to work very closely with [Fed Chair] Powell.

Biden already saw that he might not have as much freedom to do what he wants on the fiscal side with tax policy and spending policy. And if he doesn't get both Senate seats in Georgia on Jan. 5, it would be very helpful to the administration to be able to get its stimulus and funding for some programs done through the Fed.

One of the pet projects of Nancy Pelosi and other Democratic officials is try to get more money for state and local governments that are in desperate straits because their revenues have taken a dive. The Republicans don't want to do that because a lot of these municipalities tend to be run by Democrats. But if instead that kind of support can be funded through the Fed, that would be a way to get around Congress.

Again, fiscal policy's hard to get implemented without a real serious crisis. Yellen can work with Powell on bringing back some of the lending programs that [current Treasury Secretary] Mnuchin took away, and leverage up $450 billion and $4 trillion worth of loans. The administration will still be able to get a lot of what it wants done.

ETF.com: What’s a metric or gauge investors should pay attention to?

Yardeni: One market that’s definitely free and clear of government meddling is commodities.

Oil may be manipulated by the oil exporters, but I think even they'll no longer have the kind of power they used to have. I’d say investors should pay attention to commodity prices.

It could be the price of copper; sometimes some of us economists with a great deal of respect refer to copper as Dr. Copper or Professor Copper, the professor with a Ph.D. in economics. The price of copper has been accurately anticipating that we would get a V-shaped recovery, and it reflects global supply and demand. And it remains very strong. That should be good for stocks. If the central banks weren't manipulating the bond market, it’d probably push bond yields higher.

And it's not just copper. Lumber's been telling us that we've got a housing boom in the U.S. And if we have a housing boom in the U.S., that's copper pipes, so that's also good for copper. Generally speaking, even agricultural commodities tell you whether people are doing better and eating more, and so on. Commodity prices have a very strong correlation with economic activity and with other markets.

My favorite index for commodities is the CRB Raw Industrial Spot Price Index. I like it because it doesn’t include oil, which has its own supply and demand. But it does include copper, and includes lumber, which has its own supply and demand. If I were an individual who doesn't have a lot of time to spend on all this, but want to be apprised of where the pressures are, I’d keep track of the lumber market, the copper market and the CRB Raw Industrials Index.

Drew Voros can be reached at [email protected]

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