The Inventor Of 'Bond Vigilantes' Explains Why They Just Showed Up In Italy

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:15)

And I'm Joe Weisenthal.

Tracy Alloway (0:17)

Joe, what is the most overused quote in all of financial journalism and commentary?

Joe Weisenthal (0:25)

I don't even know where to begin with that question. I don't know, I'm stumped.

Tracy Alloway (0:32)

Well, it might not be that obvious, actually. Okay, in my humble opinion, it has to be the quote by James Carville, the Bill Clinton advisor about the bond market. Did you ever hear that one?

Joe Weisenthal (0:43)

Oh, yeah, yeah, I love that quote. The one about James Carville saying that he wishes, or he said if he gets reincarnated, he'd like to come back as the bond market because that can scare everyone, right? Something like those long, those lines?

Tracy Alloway (0:56)

Yeah, that's a pretty good paraphrase.

He said, so that I could intimidate everyone. And I have to say, if you're a financial writer, I guarantee you at some point or another, you have probably begun a column or a story with that quote.

Joe Weisenthal (1:10)

But I think that's probably fair to say.

Tracy Alloway (1:12)

Yeah, and I'm certainly guilty of it, I have to admit.

But there's a reason that it resonates so much, which is that the power of the bond market is something that we're constantly discussing. And Joe, you'll remember a couple episodes back, we did have one episode where we were discussing the return of the bond vigilantes.

Joe Weisenthal (1:34)

Yeah, absolutely right. And it's what the bond vigilantes, it's this idea that from time to time, policy makers have their actions rejected forcefully in the bond market, and they're cowed into action by what the market is telling them, so to speak.

Tracy Alloway (1:52)

That's right. So it's the idea that the bond market can act as a constraint on fiscal policy by basically raising a government's borrowing costs. And the reason we bring it up now is because in addition to the US context, we had that big rise in US bond yields, and people were talking about whether or not bond vigilantes were coming back because the US was embarking on this big fiscal expansion.

We've also seen the power of the bond market in recent weeks as demonstrated by what's been going on in Europe, and specifically Italy.

Joe Weisenthal (2:26)

Yeah, the old Euro crisis story is coming back in Italy.

Tracy Alloway (2:31)

That's right. It all feels very 2012 We saw a big blowout in Italian bond spreads. Everyone got very excited, started dusting off the old fiscal playbooks from circa 2010, 2011, 2012

And we all got to talk about the bond market reaction to Eurozone political and fiscal drama once again. So that was very exciting.

But of course, we do have this ongoing discussion about the bond market in general, but also how it relates to US equities. And on that note, because we had the big rise in US bond yields earlier this year, we have seen short-term rates on government debt actually go above the US dividend yield for the first time in many, many years.

Joe Weisenthal (3:17)

Yeah, I've seen a bunch of versions of this chart lately. And you mentioned the idea of short-term bond yields going above dividend yields, but there have been various variations on it. But the general theme seems to be that for the first time in a long time, you can get paid a decent amount of money owning short-term government debt, which carries very little real risk.

And the competing yield you can get from equities, whether we're looking at the dividend yield or just the straight-up earnings yield, which is the inverse of the P-E ratio, is looking less juicy by comparison.

Tracy Alloway (3:57)

Exactly right.

So we're talking about a lot of different things here, and the reason we're doing that is because we actually have a really fantastic guest for this episode who is able to thread all these different subjects together, and he is actually the person who coined the term bond vigilantes. So that's exciting.

Joe Weisenthal (4:18)

So now I feel very self-conscious for having tried to give my feeble definition of the term, because we are literally going to talk to the originator of it. All right.

Tracy Alloway (4:30)

Well, without further ado then, let's bring in our guest. It's Ed Yardeni. He is president of Yardeni Research.

Ed, thank you so much for joining us.

Ed Yardeni (4:46)

Thank you very much. And by the way, I think you got it all spot on.

Joe Weisenthal (4:51)

Okay, phew, that's a big relief.