from Lauren Steffy at the Houston Chronicle:
A New Breed of Vigilante
They are the dark knights of finance, the shadowy champions of responsible spending. Lurking on the dim edges of the bond market, they keep watch over the deficit. They are ... the bond vigilantes.
The term was coined in 1983 to describe global investors who, unhappy with rising U.S. spending, drive up bond yields, forcing government austerity. Unseen for 15 years, the bond vigilantes may be at work again as the nation faces a staggering $1.9 trillion deficit to fund a stimulus aimed at breaking the worst recession in decades.
Runaway spending fuels inflation, which is the enemy of bond investors, driving them away from government debt and the dollar. As a result, the government has to pay higher yields to woo them.
“The bond vigilantes are saying, ‘You better watch your spending, because we’re going to push rates higher,’ ” said Rick Kaplan, a portfolio manager with Houston-based Legacy Asset Management. “We’ve never printed this much money before. Our budget’s never been this out of whack. That’s bringing the vigilantes out in full force.”
Health care burden
The final straw may be health care reform. If President Barack Obama pursues his health care agenda, it may add as much as $500 billion in spending.
The last time the bond vigilantes swung into action, it was to gut Bill Clinton’s health care spending plan in the 1990s, forcing him to focus on deficit reduction. Now, however, the economy is much more precarious. The Federal Reserve wants to keep interest rates low to shore up the housing market and cut borrowing costs for businesses.
That’s why Fed Chairman Ben Bernanke recently told Congress that we had to address the deficit. He’s trying to talk down the bond market, Kaplan said.
Low mortgage rates have been a key focus of the Fed’s recovery plan, but the market has been moving the wrong way. Rates on a 30-year fixed-rate mortgage jumped as high as 5.45 percent last week from as low as 4.85 percent in April. At the same time, yields on the benchmark 10-year Treasury note rose as high as 3.9 percent, up from about 2.2 percent in January.
“That’s what’s got everybody freaked out,” Kaplan said.
False sense of recovery?
At least, those who are paying attention. Many investors are too busy looking at the stock market, where the roughly 40 percent rise in the Standard & Poor’s 500 Index since February may be creating a false sense of economic recovery.
“That’s the barometer, and I think that’s misleading,” Kaplan said.
Gold prices, for example, have risen 18 percent since January, a sign the market sees inflation on the horizon. That doesn’t bode well for Bernanke’s plans because if mortgage rates climb, housing prices will fall, prolonging the recession.
“He wants the economy to stay just where it is,” Kaplan said. “He has no interest in raising rates.”
On a tightrope
It’s a difficult tightrope for the Fed to walk. On the one hand, it’s injecting trillions into the economy to combat the recession while on the other trying to keep rates low and shrug off inflation.
Outside of the Fed’s machinations, the economy seems to have few catalysts for recovery. For the past two decades, the market has been driven by financial engineering, deregulation, lower taxes and technological improvements, none of which is going to save us now. Corporate earnings are weak, casting suspicion on the equities rally.
Against a backdrop of mounting debt and increased spending, frustrated investors have had enough.
So this may be a job for the bond vigilantes. The problem for consumers is the bond vigilantes aren’t so much heroes as mercenaries. They may succeed in putting the brakes on spending, but they won’t save us from higher borrowing costs or a lingering recession.
Loren Steffy is the Chronicle’s business columnist. His commentary appears Sundays, Wednesdays and Fridays. Contact him at loren.steffy@chron.com. His blog is at http://blogs.chron.com/lorensteffy/.
