What is a Bond Vigilante?

A bond vigilante is a bond trader who threatens or actually sells a large amount of bonds to protest or signal disgust with the policies of the issuer. Selling bonds lowers their prices, which drives up interest rates and makes borrowing more expensive for the issuer.

The term was coined by investor Ed Yardeni in the 1980s when bond traders sold Treasuries in response to the growing power of the Federal Reserve and its policies over the US economy.

Understanding Bond Vigilants

Bond yields represent the interest rate at which issuers can borrow from investors. Interest rates also have a negative correlation with bond prices: as yields rise, bond prices fall. The same association, however, also works if bond prices fall first – yields are forced to rise in turn.

Because of this fundamental relationship, bondholders can increase borrowing costs on issuers by selling their bonds at ever lower prices. Raising borrower returns in this way can be used to punish the issuer for pursuing certain actions or policies. For instance, in the early 1980s, during a period of rising inflation, the Fed initially remained fairly accommodative, leaving rates largely on their own. However, bond vigilantes soon emerged to protest the policy, as they believed rates needed to be much higher in order to curb inflationary pressures. The massive sell-off of government bonds in this way eventually drove up rates in the market, and the Fed quickly followed suit and shifted to a more falcon position.

Bond vigilantism demonstrates that market participants, and especially bondholders, have great influence that they can exercise (or threaten to exercise) over borrowers.

Link Vigilance Episodes

The investment strategist Ed Yardeni came up with the term bond vigilante to describe the actions of large bond traders in the treasury bill market. During the inflation of the 1980s, it said that“Even before the Fed really started aggressively raising interest rates, the bond vigilantes saw that and kind of took the lead and drove interest rates up dramatically.”

In the early 1990s, bond traders were frustrated by the massive government spending that initially took place under the Clinton administration, pushing 10-year Treasury yields up by around 5% to 8% over the course of the year. of a year. Once the policy changed to reduce the deficit, yields fell again.

Following the financial crisis of 2008, several European economies found themselves in a debt crisis, mainly the so-called PIIGS country – Portugal, Ireland, Italy, Greece and Spain. Recognizing the massive amounts of debt owing, sovereign debt yields for these countries have skyrocketed. As Yardeni notes, “When these Yields on Greek bonds went to 40%, they were clearly screaming that something was seriously wrong with the way [the] country was run, and things changed and those bond yields went down.” Yet some blame bond vigilantes for making it harder for those countries to recover because bond vigilantes pushed yields so high it was costly to borrow, and ultimately to function properly.

Bond vigilantes versus activist investors

Bond vigilantes show that markets and large market participants can greatly influence the behavior of issuers of the securities they trade.

Another example of this concept is that of activist investors. They are large shareholders who accumulate enough stake to force changes in the management and direction of the company. These activists are able to rack up enough voting power as shareholders to secure board seats and replace corporate executives like the CEO. They may also threaten to sell their shares in the market, depressing the stock price and lowering the market value of the company (known as exit power).