Early last week I was writing a post on the Bond Market Vigilantes when I noticed a peculiar thing--they seemed to have abruptly disappeared.
For those of you who aren't familiar with it, the term Bond Market Vigilantes refers to bond investors who push interest rates up even as policy makers are trying to keep interest rates low. Just like in comic books and old westerns, bond market vigilantes step in to correct what they see as weakness in the regularly constituted authorities.
This is clearly what has been happening for most of this year. As you can see in the following chart, yields on ten year U.S. Treasury bonds steadily rose from 2.24% on January 14 to a recent peak of 3.98% on June 10. This kind of move wouldn't mean much if the Federal Reserve were trying to tighten monetary policy. But the fact that interest rates rose by 175 basis points in the face of the Fed's efforts to keep interestrates down is a very big deal.
What caused rates to rise so quickly? Fears of accelerating inflation. Remember inflation is the bane of bond holders. If bond investors believe inflation is going higher, they buy fewer bonds and interest rates go up.
But suddenly the pressure seems to have evaporated--at least for the moment. Over the past week, 10 year treasury yields dropped 50 basis points even as the Treasury issued a record $104 billion in debt. Today's Wall Street Journal has an interesting (and short) article on this recent shift. Here's a brief excerpt:
Given the Fed's heavy and unpredictable hand n the market lately, buying Treasury's ahead of a Fed meeting is a little like trying to sneak a doggy biscuit away from asleeping pit bull. But investors couldn't get enough. Those likely included China, whose top central banker suggested this weekend that the No. 1 holder of Treasury's wouldn't sell anytime soon.
Personally, I welcome the moderation in interest rates. We still have a lot of banking system troubles to work through, including the refinancing of a lot of troubled real estate. Higher rates only make that process more difficult.