Bond Vigilantes are back, and they are tightening in place of the Fed like they did in the early 1980s.
While the Federal Reserve controls short-term interest rates, it is far more difficult to manipulate the bond market and long-term rates. Historically, when it is perceived that inflation is returning or reheating, large bond investors (also known as bond vigilantes) start selling – driving yields higher. This effectively raises interest rates, whether the Fed wants to or not! As a result, a Fed rate hike is not essential to have a monetary impact.
So even while the Fed is taking their time reacting to reappearing inflationary pressures, including skyrocketing oil prices, the bond vigilantes have been hard at work. The 5-year Treasury yield has risen over 0.5 percentage points in March. That is more than the equivalent of TWO quarter point rate hikes by the Fed! It now sits at the highest level since July of last year. Over the same time period, the 30-year yield has risen 0.3 percentage points and is once again approaching 5.0%.
If Treasury yields continue to move higher, it could have far reaching consequences – quashing investor confidence and raising borrowing costs. Higher borrowing costs would likely cause further trouble for the housing sector and potentially the already deteriorating private credit market.