Review & Outlook

Our take on the investing, financial, & economic themes of the day

It’s All About Bond Vigilantes Now

18 June, 2012 by Ben O'Brien in Commentary

Every morning at 11:00 AM this office has a conference call to talk about the news.  We invite a broker to join us, and he provides a different perspective.  What usually starts the conversation is a newly released government statistic  about industrial production,  housing starts, new home sales, trade deficits or one of a thousand other statistics the government releases.  We try to figure out what the statistic means, how it fits in with others and, as the expression goes, whither we are tending as an economy and as investors.

One statistic alone seldom tells much of a story. Rather one looks for a pattern.   But last week there was a report that tells the whole story of what’s driving the markets at the present time.  The particular statistic came from Spain. Every month Spain auctions  a 3-year note.   Last month the yield was 3.91%.  This month it was 5.30%.  So in a single month the cost of financing the government of Spain jumped 36%.  That’s a big deal.  That’s how fast yields and markets can change.  Who’s behind the change?  Investors from around the world whose collective assets are near-to unlimited.  The press has given them the colorful names of  “bond vigilantes.”   When they become alarmed–and they are alarmed, watch out:  the status quo is about to change.

The bond vigilantes are of course public opinion.  There are few forces as powerful.  Even a sovereign nation, like Spain, is powerless when public opinion turns against it.  Think of the Berlin Wall and the fall of the old USSR. The phenomenon now finds expression in the cost of money for European countries, and money is like oxygen to a government.  You tend to take it for granted when it’s there; when it’s in short supply, it is all that matters.  That’s where Spain is (and Greece), and the fear is that other nations – – even us – – may be there in short order.

Presently America, along with other safe haven-nations like Switzerland and Germany, are the beneficiaries of the bond vigilantes.   (A 3-year U.S. government note has a yield of .37%, as compared to the 5.3% yield of the  Spanish 3-year note.)  But it is still an uneasy sort of advantage we enjoy, for public opinion is notoriously fickle, and in the tax and spend department, America does not exactly have clean hands. The vigilantes will likely turn on other spendthrift nations in the twinkling of an eye, for there is absolutely no loyalty or generosity in markets.  The fear is that anyone, even us, could be next.  But this fear is not necessarily a bad thing.  Tomorrow I’ll explain why.

Mark O’Brien