The bond market is like the proverbial mama in the old adage, “If mama’s not happy, then nobody’s happy.”
Ever since the Clinton years, when the bond vigilantes—investors who would demand crippling high returns if we failed to obey them—allegedly ruled, more policy than you’d like to think is deeply influenced by warnings of how the bond markets will react.
The thing is, nobody really knows how they’ll react. So they become a Rorschach Test wherein you can see, and argue for, whatever it is you want. I half expect my 11 year old to warn me that that the bond market won’t be pleased if she doesn’t get to go to that pricey horse-riding camp this summer.
Take, for example, this quote from yesterday’s CQ (subscription req’d):
“Mark Warner, D-Va., expressed concern that a bipartisan, bicameral group of lawmakers led by Vice President Joseph R. Biden Jr. might not be able to agree on enough deficit reduction to give the bond market confidence that the nation is getting its debt under control.”
Well, you sure can’t see that by looking at the yields. Such fears should lead those buying new bonds to insist on protection against interest-rate risk (when rates go up, the value of the bonds you’re holding go down) but you don’t see that at all.
Source: Bloomberg, 10 yr T-bills
So you say, “well, the market is mistakenly discounting such fears.” But this doesn’t make sense. If the market is too inefficient to recognize that it needs appeasement, how will you know when it’s appeased?
And why appeal to market mind reading, anyway? Occam’s razor and all that…at first blush, low interest rates on American Treasuries are reflecting weak growth, low inflation outlook (i.e., core inflation, leaving out energy/food prices), Fed zero-rate policy, and flight to safety from the debt situation in some European countries where, btw, you can very clearly see rational investors demanding high yields from deeply troubled economies.
What about the threatened downgrade by Moody’s and S&P? You’re forgiven if your faith in the rating agencies to get this right is shaken by their role in inflating the housing bubble, and thus far, their announcements haven’t had much apparent impact.
Now, were we to actually default on our debt (by failing to raise the debt ceiling), a lot of very bad things would happen. I’ve asked bond market investors why we don’t see obvious signs of that anxiety in the market, and they’ve basically answered, “we assume you DC guys will eventually take care of it.”
I think and hope they’re right. If not, we are likely to see the bond market go nuts and I’ll be the first one to comment on the interest rate impact of terrible policy mistakes. Until then, I don’t want to hear any talk about fancy horse riding camps.