Bond vigilantes have resurfaced in a big way to the Fed's decision to hold rates steady, pushing up yields on long-term Treasuries to their highest levels in nearly 20 years.
The yield on the 30-year Treasury rose a tenth of a percentage point to 5.20% after the central bank's announcement Wednesday afternoon and was still there Thursday morning. On a 9-3 vote, the Fed kept the fed-funds rate at 3.5% to 3.75%.
Investors are pushing long rates higher because they sense new Fed Chairman Kevin Warsh doesn't want to hike rates to rein in inflation, which is above the Fed's annual target of 2%. The latest numbers, the June PCE released Thursday, puts overall inflation at 3.7% and core inflation at 3.3.
The bond vigilantes -- the collective group of retail and institutional investors investors who step in to change long-term rates when the Fed won't act on short-term ones -- can clearly mpact the stock market like they did Wednesday when the S&P 500 fell 1.5%.
Higher long rates are a negative for stocks, particularly high-multiple growth names, because competition from bonds makes stocks less appealing.
The bond-vigilante phrase recalls a 1994 quip from Clinton presidential adviser James Carville:
"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter," he said. "But now I would like to come back as the bond market. You can intimidate everybody."
The vigilantes were quiet for much of the past two decades, but they are becoming a force to be reckoned with these days.
One is veteran market watcher Ed Yardeni, who founded and leads Yardeni Research.
Yardeni, in a note Thursday, pointed out that his firm correctly anticipated the Federal Open Market Committee would turn hawkish in June. The, he predicted a hike rate at the committee's July meeting, which was Wednesday. That didn't pan out.
"Once again, the Bond Vigilantes are pushing bond yields higher. In effect, they are saying that if the Fed won't be vigilant about inflation, then they will have to maintain law and order in the economy, " wrote Yardeni, who is also an economist.
"Under the circumstances, we conclude that the Fed has to raise short-term rates to lower long-term rates. Talking hawkish but not acting so reduces the Fed's credibility."
Another bond market guru, DoubleLine chief Jeff Gundlach, who is active in the mortgage securities market, recommends that investors pay attention to the yield on the 2-year Treasury note to find out where bond investors think the fed-funds rate should be.
The 2-year is now at around 4.25%, indicating the markets expect at least a half-point rise in short rates. The CME's FedWatch indicator shows that expectations indeed are for higher short rates by early next year with an 80-plus% chance of at least a quarter-point hike in short rates.
The question is whether the Fed will raise rates and generate blowback from President Donald Trump.
The vigilantes have another good reason other than inflation to act.
The federal deficit is running at about $2 trillion this fiscal year -- about 6% of GDP -- with no meaningful improvement in sight. That likely means a lot of bond issuance in the coming years, which would put upward pressure on rates.
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