How Bond Vigilantes Made Trump Blink

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Bloomberg 10:10 · 7014 Views

US President Donald Trump retreated from his sweeping “reciprocal” tariffs after a bond selloff sent Treasury yields soaring. But who are the much-feared bond vigilantes behind his reversal?

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00:00 Get your savings out when you're hearing shout many bonds today,
00:04 come on again.
00:05 During economic crises, U.S.
00:07 Treasury bonds are usually financial safe havens.
00:11 This time,
00:13 not so much.
00:14 They were right at the heart of the sell off.
00:16 Maybe investors don't like these tariffs and they're finding
00:18 ways to move into alternatives.
00:20 And that pushed up yields or interest rates demanded by investors to buy government debt.
00:27 Yields on 10 year U.S.
00:29 Treasuries skyrocketed 49 basis points in one week.
00:33 That's the most in more than two decades,
00:37 the last time being here in 2001 during a recession that followed the.com bubble.
00:43 The bond market had assessed Trump's tariffs
00:46 and responded with a message.
00:47 We're not sure we're safe leaving our money in the US anymore.
00:52 Now, neither trillions of dollars of lost value in equity markets nor the chorus of alarm from world leaders had changed Trump's mind.
01:00 But angry bond investors?
01:02 I
01:02 was
01:03 watching the bond market.
01:04 The bond market is very tricky.
01:06 I was watching it.
01:07 That's what got him to press pause on his tariffs,
01:10 which is very reminiscent
01:12 of what happened in the early 1990s
01:14 when President Clinton's advisors
01:17 warned him that he has to kiss the ring of the bond vigilantes.
01:21 So who are these bond vigilantes
01:24 and why do they play such a significant role
01:27 in shaping policy?
01:35 Let's start with something everyone's heard of
01:37 a lettuce.
01:40 In 2022, one of these became a humiliating political metaphor.
01:45 I will drive reform in my mission
01:48 to get the United Kingdom working, building and growing.
01:52 Liz Truss, who had just taken over as Prime Minister,
01:55 announced a budget where she made very big tax cuts that weren't funded.
02:00 The bond markets completely freaked out.
02:03 They sold UK bonds massively.
02:06 That in turn sent bond yields skyrocketing to multi year highs,
02:11 underperforming US peers by the most in years, which you're seeing here as a difference in basis points.
02:18 The prospect of much higher borrowing costs hit home
02:22 and spurred the government to basically give up their plans.
02:26 The economic fallout was so dire, a column in the Economist suggested Truss's premiership had the shelf life of a lettuce,
02:35 so a newspaper live streamed one to test the theory.
02:38 I am resigning as leader of the Conservative Party.
02:42 The lettuce had won,
02:43 and the bond vigilantes claimed another victory.
02:47 In the hierarchy of market forces that shape political outcomes,
02:51 history shows bonds at the top.
02:54 A bond is like an IOU.
02:57 So you have an issuer, which might be a country or a company,
03:01 and in exchange for buying a bond you will get interest payments
03:06 all the way until the bond reaches maturity.
03:10 Maybe it'll be a two year bond or 30 year bond,
03:13 but the idea is, is that you're locking in a yield for a certain amount of time and you know what that interest rate over that time period will be.
03:20 It's why they're favoured by long term investors such as pension firms and increasingly sovereign wealth funds.
03:27 More on that later.
03:29 Governments use the proceeds to fund everything from hospitals to schools to
03:34 bridges and infrastructure.
03:37 The bond market is kind of like
03:39 the banker for a
03:41 big government.
03:42 In 2024, global government debt stood at around $100 trillion.
03:48 So ignoring the concerns of the metaphorical banker
03:52 is unwise.
03:53 Bond investors are the ones
03:56 that are owed money.
03:57 Governments have
03:59 to respect that,
04:01 and if they fear that inflation could get out of control,
04:04 they will essentially exert their influence.
04:09 People who
04:10 are ultimately
04:11 behaving as though they're the bankers for the governments suddenly think,
04:15 I don't trust this government anymore,
04:18 I don't like this, and I'm going to put up the interest rates I demand from them.
04:22 And when you're talking about $2 trillion a year, the kind of money that the US has to borrow each year,
04:30 that's adds up very quickly.
04:32 It would impact everything from mortgages
04:36 to bank profits overnight
04:39 to repayments on trillions and trillions and trillions of dollars of loans.
04:44 You can think of it as a really painful meeting with your bank manager.
04:49 You're overdrawn again.
04:51 No,
04:51 no more money for you.
04:53 And in essence, that's the power held by bond vigilantes.
04:57 You can
04:58 use the bully pulpit
05:00 in the same way that an activist investor attacking a company can use the bully pulpit to attack stock.
05:07 Basically, if you
05:08 sell your bonds and tell everybody why you're doing it.
05:12 So what's the back story here?
05:15 My name is Ed Yardeni and I coined the phrase ban vigilantes.
05:21 In the early 80's.
05:22 The bond investors became very, very twitchy 3 times in the 1980's.
05:26 The rebound in inflation was met by rising bond yields, which slowed nominal GDP down, which slowed inflation down.
05:35 In the early 1990s,
05:37 Bill Clinton was told by his advisors
05:40 they had to maintain fiscal discipline because if they didn't,
05:44 the bond market would have set their plans.
05:46 Clinton took that to heart and maintained A relatively disciplined
05:50 fiscal policy.
05:52 Then in the 2000's, the vigilantes appeared to have taken a trip to Europe.
05:57 A reporter asked me about what was going on in Greece.
06:01 I said, what do you mean?
06:02 Well, I said, look, the bond yield has gone from under 10% to 40% in a very short period of time.
06:09 Is it possible that the bond vigilantes basically have taken a vacation in Greece, then realized that they had a problem with that government?
06:17 Now the bond vigilantes are actually more powerful than they've ever been,
06:21 simply because there's a lot more debt than we've ever had.
06:24 The governments that are most vulnerable are the ones that have borrowed what the market would think is too much for the track to bear.
06:31 We now have so much debt
06:33 that has been accumulated.
06:35 By the United States that just paying the interest on that and we're talking about a trillion dollars in interest payments
06:42 and so investors are assessing alternative places to take their cash.
06:47 They are now
06:48 nervously looking at German bunts
06:51 as being safer than U.S.
06:53 debt.
06:53 Conceivably
06:55 a bunt is a German bond
06:57 and look what's happened to the spread.
06:59 In other words, the difference between US and German 10 year bond yields.
07:03 This small looking percentage point difference actually represents a surge in the gap between the two as investors look to reduce their exposure to US assets.
07:13 Germany is a really good example of
07:16 where bond vigilantes have less power, where it hasn't issued as much debt as places like
07:22 the UK or the US, where the proportion of debt to output is over 100%.
07:28 In the case of Germany, it's just over 60%.
07:31 Central banks, like the US Federal Reserve, also have tools that can thwart vigilantes.
07:36 So you might have heard of a concept called concentrated easing, which is when central banks
07:42 step into markets and buy billions and billions worth of EUR or dollars or pounds of bonds.
07:48 After the 2008 financial crisis, the Fed bought trillions of dollars of bonds, pinning yields near historic lows.
07:56 This is usually a last resort.
07:58 We've recently seen the end of an experiment where the Bank of Japan tried to keep the 10 year yield on Japanese government bonds to 0.
08:08 It successfully did do that, but
08:11 at the cost,
08:12 arguably, of distorting the Japanese economy.
08:15 Interestingly, though, Japan is the biggest owner of U.S.
08:19 debt, followed by China.
08:22 One of the most important
08:24 trends in the bond market in recent years has been
08:28 the growth of foreign ownership,
08:31 particularly China.
08:32 China owns about $700 billion of U.S.
08:35 Treasuries.
08:36 It's
08:36 because China exports 3 times more to the US than vice versa.
08:43 That means they accept a lot of U.S.
08:45 dollars.
08:46 They use the money and pump it back
08:49 into the Treasury's markets
08:51 that are safest assets in the world, and they also provide China with income.
08:56 China's vast holding of American debt, coupled with the frenetic advance of a bilateral trade war, led to speculation that China could in theory, become a bond vigilante.
09:07 Will China do it?
09:10 Unlikely.
09:12 If it sells a lot, it will hurt itself because it will push down the value of its own Treasury bonds.
09:19 More like shooting
09:20 yourself in the foot as well as shooting the other guy.
09:24 So where does this leave Trump in the eyes of the bond market?
09:28 Could we see an American version of the Truss lettuce?
09:32 There are a lot of similarities between the Liz Truss moment in 22
09:38 and what we've experienced with Donald Trump.
09:41 In both cases,
09:43 it wasn't just that
09:45 they announced a policy that markets didn't like,
09:48 it was that they did something that the markets truly believe to be dumb.
09:53 the US these days is a far bigger,
09:55 more powerful, more resilient economy than the UK.
09:58 You have much more room to manoeuvre
10:01 than even the UK does
10:03 in terms of long term implications of what this could mean for the Trump administration.
10:08 If they do not address some of the key concerns by bond investors,
10:12 expect yields to spike.
10:15 The really long term risk for Trump is that trust has already been damaged.
10:22 If people no longer trust the US to be a reasonable good faith interlocutor,
10:29 it's going to be very hard to get that back.

How Bond Vigilantes Made Trump Blink

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