Rising long Treasury yields -- bond vigilantes at work?

September 2023 saw a sudden rise in Treasury yields, especially at the longer end, despite the Federal Reserve holding the short-term fed funds rate constant. Moderate to longer term Treasury yields have a strong impact on consumer and business borrowing rates.

The increase is a real (inflation adjusted) increase, as shown by the spike in TIPS yields. The 10-Year Expected Inflation rate is only 2.2%.

Before 2008, long-term bond yields were set by supply and demand in the market. If bond traders anticipated inflation or excess debt issuance, they would demand higher yields to compensate. “Bond Vigilantes” pressured the government to control inflation because otherwise they would charge the government higher interest to lend.

Starting in 2008, the Federal Reserve repressed long-term yields by buying immense amounts of Treasury and mortgage debt (“Quantitative Easing”). The Fed trumped the bond vigilantes, forcing yields lower until the real yields were negative. But the Fed began to back out of the bond market in 2022, gradually allowing its bond holdings to roll off when they matured (“Quantitative Tightening”). Now the traditional market forces setting the price of borrowing have more power.

Have the bond vigilantes returned to push up real yields? Forecast future government deficits are immense so it would make sense to demand higher real future yields.

The Fed has declared that, once inflation is under control, it wants to return to a neutral monetary regime – one that neither stimulates nor slows the economy. For economic calculations, this is called r* (“r-star”). r-star is defined as “the real short-term interest rate expected to prevail when an economy is at full strength and inflation is stable.”

Different Fed analysts disagree on r*.

This is the short-term fed funds rate. It does not account for fiscal stimulus changes from government spending or the long-term yields set by the market.

How long will real Treasury yields remain at their current level? Will they continue to rise? Paul Krugman, as usual, is an optimist and believes that both elevated inflation and high real yields are transitory. But even he is uncertain. The WSJ points out that rising Treasury yields are a strain on the U.S. budget. But cutting the deficit is next to impossible.

Treasury prices are currently in “falling knife” mode since bond prices move opposite their yields. How long will this go on? Even the pros don’t know. Meanwhile, TIPS yields are the highest they have been since 2008. It might be worthwhile to cash in the I-Bonds bought in 2020-2021 and buy TIPS. (This will sacrifice 3 months of interest.)



Yes, the Bond Vigilantes are back, but they are only trying to make a reasonable return. 10-year Treasury interest rates have been rising since May when there was a Debt Ceiling crisis. Both Fitch and Moody’s have clearly stated that threats of the Debt Ceiling and Government Shutdown harm the U.S.'s credit ratings.

The threat of a U.S. federal government shutdown contributed to the interest rise this month. Today it looks like the shutdown will be avoided. But interest rates are sticky and so will stay high or even go higher. Once trust is lost, it is difficult to regain.

The Fed is no longer shielding the bond market from these events. As a bondholder, I am OK with higher interest rates, but am mostly staying in 6-month bills until long term rates stabilize. As a taxpayer, I am annoyed at the DC antics that cause higher costs with no benefits.

=== links ===

US government shutdown bad for country’s credit, warns Moody’s, September 25, 2023
“A U.S. government shutdown would harm the country’s credit, rating agency Moody’s said on Monday, a stern warning coming one month after Fitch downgraded the U.S. by one notch on the back of a debt ceiling crisis.”

What Is a Bond Vigilante?
“A bond vigilante is a bond trader who threatens to sell, or actually sells, a large amount of bonds to protest or signal distaste with policies of the issuer.”

10-year Treasury yield is up 46 bp in the last month.

Control Panel: Countdown to debt ceiling crisis, May 14, 2023
“The markets are holding their breath while waiting to see what happens with the debt ceiling crisis that Treasury Secretary Janet Yellen warns may happen in June.”

Long-Bond Yield’s Biggest Jump Since ‘09 Has Ackman Eying 5%, September 28, 2023
30-Year Treasury yield is up about 82 basis points since June
Investors are in ‘fear stage,’ Brandywine’s McIntyre says