C.J. Lawrence Weekly – Is U.S. Economic Growth Reaching a Peak? The Bond Vigilantes May Tell Us.
In the early 1980’s our former Deutsche Bank colleague, Dr. Ed Yardeni, coined the phrase “Bond Vigilantes” to describe bond market reactions to loose fiscal policy. When the federal government threatened to ramp debt-fueled spending, the Bond Vigilantes would ride in, sell treasuries, and push yields higher, administering the market’s own justice on issuers. During the “Great Bond Massacre” in late 1993 – early 1994 the yield on the U.S. 10-Year Treasury Bond rose from 5.1% to 8.0% in response to fears of massive federal government spending increases. The U.S. Treasury is currently engaged in another massive funding cycle, issuing increasing amounts of debt to fund the country’s mounting budget deficit. But so far, the Bond Vigilantes have kept their guns holstered and foreign buyers of treasuries don’t look poised to join their posse if they ride again. Strong demand for treasuries, and the specter that U.S. economic growth could slow because of trade wars, could keep the Vigilantes at bay.
The Treasury International Capital (TIC) data on August activity showed that foreign buyers purchased more U.S. bonds than in previous months. U.S. 10-year paper, with a ~3.2% coupon, still looks relatively attractive versus paltry European sovereign yields hovering around 0.46% and Japanese 10-year paper at 0.14%. But wide spreads on global sovereign debt is not the only demand driver for U.S. treasuries. U.S. households continue to be large buyers of treasury securities as they express skepticism of the bull market in stocks. Even in the face of growing issuance, the U.S. Treasury is finding buyers for its debt. During the week of October 8, the U.S. Treasury held bond auctions for $36 billion in 3-Year notes and $23 billion in reopened 10-year notes. The bid-to-cover ratios for both auctions were slightly lower than previous auctions, but they were fully subscribed, and yields are now back below auction levels.
But the day-to-day movements in yields may be less important than the changing narrative around the prospects for global growth and the potential impact that slowing international trade could have on the U.S. economy. A growing chorus of investors and market watchers are recalibrating 2019 and 2020 growth expectations on the back of rising fears that a slowdown in trade will ultimately catch up with U.S. companies and crimp the expansion. This path would likely lead to slower top-line growth for U.S. companies and pressure future earnings power. Meanwhile, consensus forecasts remain for the Federal Reserve to continue its telegraphed path of Federal Funds target rate hikes, and for the long end of the yield curve to follow suit. With a backdrop of heavy issuance, the prospect for the Bond Vigilantes to re-emerge and force an even sharper steepening of the yield curve would be a likely outcome under that scenario. But these two paths cannot run parallel for long. Eventually one will dictate market direction and psychology. Expectations still favor Bond Vigilante intervention and higher rates. However, their inaction, in the face of growing Treasury bond issuance, would be an important signal on the trajectory of growth and inflation.