Higher interest rates and growing government debts and deficits have led many financial commentators to wonder if policymakers in major economies should be more worried about the bond markets - a famously exacting source of discipline when all else fails. Are they on to something?
PS Quarterly regularly features predictions by experts on topics of global concern, and as we move further into 2025, the macroeconomic outlook has moved to the top of the list. Following the long era of low interest rates during the 2010s, the return of inflation and higher sovereign bond yields since the pandemic has led many in the financial press to proclaim that the “bond vigilantes are back.”
Coined by the investment strategist Edward Yardeni in the 1980s, the term captures sovereign-debt investors’ role of constraining the scope of economic policymaking. While traditionally associated with chronically troubled economies like Argentina, the bond-vigilante effect is increasingly factoring into analyses of major advanced economies such as the United States, too. Nor is this development confined to speculation by pundits. “If you’re seeking clues about the potential for bond vigilantism, you might start by asking the largest fixed income investors – who theoretically hold the most market sway – what they’re doing,” write two strategists at PIMCO, which is “already making incremental adjustments in response to rising US deficits.”
To assess whether this sentiment represents a new normal, we asked contributors if they agree or disagree with the following proposition:
“Bond vigilantes” will become a persistent issue for major economies.
Almost every time that bond yields jump higher just about anywhere in the world, I get at least one reporter calling me asking if the bond vigilantes are behind the move. I coined the term back in the July 27, 1983, issue of my weekly commentary, under the headline “Bond Investors Are the Economy’s Bond Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”
Of course, bond investors are not thinking about regulating the economy. They are simply acting in their perceived financial best interest – that is, out of increasing or decreasing concern that inflation might erode the effective purchasing power of their returns. A related concern is that deficit-financed fiscal policy is excessively stimulative, which increases the risk of inflation and adds further to the debt. Excessively stimulative monetary policy is especially alarming if it is enabling the profligacy of fiscal policy.
The bond vigilantes did play an important role in regulating the business cycle during the 1980s. They were less important during the 1990s, because US President Bill Clinton was warned by his economic advisers to maintain fiscal discipline or face their wrath. Now, it seems that US Treasury Secretary Scott Bessent is trying to convince his boss, President Donald Trump, that the bond market is more important than the US Federal Reserve.
The bond vigilantes are biding their time, waiting to see how the Trump administration will slow the increase in spending as a result of the Department of Government Efficiency’s efforts. If they don’t deliver enough spending cuts, there could be a gunfight at DOGE city, with the bond vigilantes shooting holes in Trump’s fiscal agenda, including his promised extension of the 2017 tax cuts.
I disagree with the proposition. Even smaller countries’ greater vulnerability to bond vigilantes will be occasional, rather than persistent. Nonetheless, such vigilantism – understood as financial markets constraining governments’ choices – could prove effective not through bonds but rather equity markets.
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Consider the basic arithmetical expression of public-debt sustainability: The rate of economic growth (“g”) must exceed government bond yields (“r”), or the government must achieve an offsetting primary (excluding interest payments) budget surplus. Major economies that issue public debt in their own currencies can cap “r” by creating money. Similarly, ever since 2012, when then-European Central Bank President Mario Draghi promised to do “whatever it takes” to save the euro, eurozone countries that lack monetary sovereignty have relied on the ECB for the same purpose. In these cases, vigilantes have learned not to bet against central banks.
What about “g”? As someone who disagrees with the “secular stagnation” school, I would point out that today’s higher interest rates reflect stronger demand for capital to fund productivity-enhancing investment. The resulting positive growth trend will counter vigilante concerns about inflationary budget deficits, as well as eliminating the need for “austerity” – which has been thoroughly discredited, both economically and politically.
Of course, periodic supply shocks, especially those affecting energy, imply some residual vigilante risk. These events are bad for both growth and inflation, with the latter aggravated in the case of smaller open economies like the United Kingdom by the resulting currency weakness. Sheltered from this risk by “King Dollar,” the US faces a different problem: its pro-growth investment could be inhibited by today’s deep policy uncertainties. Still, if bad equity-market reactions can discipline the Trump administration, the US Federal Reserve can continue to support the bond (Treasury) market.
“Bond vigilantes” have always been a very big deal for any government, except for those happy few with the “exorbitant privilege” of possessing a currency and issuing debt that functions as the world economy’s safe and secure asset of last resort. For normal countries, what has been true will continue to be true: the leash will remain short, and markets will not hesitate to yank it if you tread off the beaten path.
For countries with the exorbitant privilege, sovereign debt, when properly accounted for, is not so much a cost as a profit center. It is more like the deposits held at an early-modern Medici bank – where people paid to keep their money safe – and less like that of a normal debtor under the thumb of some moneylender.
But even for the exorbitantly privileged, bond vigilantes do matter at one remove, because there is always the possibility that one will lose one’s vaunted status. That can happen very quickly indeed. And once it is lost, it can be extraordinarily difficult to regain. As such, this risk – even if it seems distant – should always reside in policymakers’ peripheral vision. If you lose sight of it, you may end up like former UK Prime Minister Liz Truss.
In the fall of 2022, Truss and her chancellor of the exchequer, Kwasi Kwarteng, tempted fate with a “mini-budget” that included $50 billion in unfunded tax cuts. The bond market was having none of it, and she was defenestrated after a mere 45 days in office. By contrast, US President Bill Clinton’s administration always had the bond vigilantes in its peripheral vision, and this played no small role in the macroeconomic policy success that it achieved over the course of eight years.
Government debt is alarmingly high. It has reached 111% of GDP across advanced economies, and 72% in developing countries. Many countries are in serious debt distress, and some have already defaulted. With interest rates relatively high, lackluster economic growth and mounting fiscal pressures will make it increasingly difficult to manage existing debts, and this will raise concerns among debt investors.
Does this signal the return of bond vigilantes? The recent spike in UK gilt yields suggests some discomfort among investors about the new Labour government’s fiscal policy. In mid-January, the 30-year gilt yield hit 5.5%, reflecting the fact that UK inflation remains notably higher than in other G7 countries. However, much of this surge reflected broader portfolio adjustments, rather than direct concerns about fiscal policy.
Even in the case of former UK Prime Minister Liz Truss’s infamous mini-budget crisis in 2022, there were mixed signals. There were certainly market concerns about the government’s plan to increase borrowing without clear funding strategies. But the crisis was exacerbated by pension funds using gilts to hedge their long-term liabilities. The sudden drop in gilt prices triggered substantial collateral calls, forcing these funds to sell more gilts and driving prices further down in a self-reinforcing cycle.
As for the US, yields remain stubbornly high. Yet this is not necessarily an unambiguous sign of investors’ dwindling confidence in US fiscal policy. Instead, it reflects the complex dynamics of US capital markets, including the large equity premium. Ultimately, US Treasuries are the world’s preeminent safe asset. No other markets for safe assets denominated in major reserve currencies offer the size and depth required to meet the massive global demand – particularly the demand for official foreign-exchange reserves. So far, this demand has been sufficiently resilient to weather the actions of disillusioned bond investors.
Anyone doubting the strong likelihood of the bond vigilantes’ return has not been paying attention to the recent, strange developments in US ten-year Treasury bond yields (as of this writing in early February). Nor have they been paying attention to President Donald Trump’s budget-busting tax-cut proposals.
Since last September, when it became apparent to markets that Trump was likely to win the election, the ten-year Treasury yield has risen by around 100 basis points even as the Federal Reserve has cut its policy rate by the same amount (from 5.25-5.5% to 4.25-4.5%). It did so on the expectation that the US budget deficit would rise meaningfully from its already worryingly high level of around 6.5% of GDP.
According to the Committee for a Responsible Federal Budget, Trump’s tax-cut proposals would add $7.75 trillion to the US national debt over the next decade, pushing the debt-to-GDP ratio above 140% by 2034. If implemented, such massive tax cuts are bound to raise serious questions about the sustainability of US public finances, and that in turn would constitute an open invitation for the bond vigilantes to return in full force.
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PS Quarterly regularly features predictions by experts on topics of global concern, and as we move further into 2025, the macroeconomic outlook has moved to the top of the list. Following the long era of low interest rates during the 2010s, the return of inflation and higher sovereign bond yields since the pandemic has led many in the financial press to proclaim that the “bond vigilantes are back.”
Coined by the investment strategist Edward Yardeni in the 1980s, the term captures sovereign-debt investors’ role of constraining the scope of economic policymaking. While traditionally associated with chronically troubled economies like Argentina, the bond-vigilante effect is increasingly factoring into analyses of major advanced economies such as the United States, too. Nor is this development confined to speculation by pundits. “If you’re seeking clues about the potential for bond vigilantism, you might start by asking the largest fixed income investors – who theoretically hold the most market sway – what they’re doing,” write two strategists at PIMCO, which is “already making incremental adjustments in response to rising US deficits.”
To assess whether this sentiment represents a new normal, we asked contributors if they agree or disagree with the following proposition:
“Bond vigilantes” will become a persistent issue for major economies.
Edward Yardeni
Almost every time that bond yields jump higher just about anywhere in the world, I get at least one reporter calling me asking if the bond vigilantes are behind the move. I coined the term back in the July 27, 1983, issue of my weekly commentary, under the headline “Bond Investors Are the Economy’s Bond Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”
Of course, bond investors are not thinking about regulating the economy. They are simply acting in their perceived financial best interest – that is, out of increasing or decreasing concern that inflation might erode the effective purchasing power of their returns. A related concern is that deficit-financed fiscal policy is excessively stimulative, which increases the risk of inflation and adds further to the debt. Excessively stimulative monetary policy is especially alarming if it is enabling the profligacy of fiscal policy.
The bond vigilantes did play an important role in regulating the business cycle during the 1980s. They were less important during the 1990s, because US President Bill Clinton was warned by his economic advisers to maintain fiscal discipline or face their wrath. Now, it seems that US Treasury Secretary Scott Bessent is trying to convince his boss, President Donald Trump, that the bond market is more important than the US Federal Reserve.
The bond vigilantes are biding their time, waiting to see how the Trump administration will slow the increase in spending as a result of the Department of Government Efficiency’s efforts. If they don’t deliver enough spending cuts, there could be a gunfight at DOGE city, with the bond vigilantes shooting holes in Trump’s fiscal agenda, including his promised extension of the 2017 tax cuts.
Brigitte Granville
I disagree with the proposition. Even smaller countries’ greater vulnerability to bond vigilantes will be occasional, rather than persistent. Nonetheless, such vigilantism – understood as financial markets constraining governments’ choices – could prove effective not through bonds but rather equity markets.
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At a time of escalating global turmoil, there is an urgent need for incisive, informed analysis of the issues and questions driving the news – just what PS has always provided.
Subscribe to Digital or Digital Plus now to secure your discount.
Subscribe Now
Consider the basic arithmetical expression of public-debt sustainability: The rate of economic growth (“g”) must exceed government bond yields (“r”), or the government must achieve an offsetting primary (excluding interest payments) budget surplus. Major economies that issue public debt in their own currencies can cap “r” by creating money. Similarly, ever since 2012, when then-European Central Bank President Mario Draghi promised to do “whatever it takes” to save the euro, eurozone countries that lack monetary sovereignty have relied on the ECB for the same purpose. In these cases, vigilantes have learned not to bet against central banks.
What about “g”? As someone who disagrees with the “secular stagnation” school, I would point out that today’s higher interest rates reflect stronger demand for capital to fund productivity-enhancing investment. The resulting positive growth trend will counter vigilante concerns about inflationary budget deficits, as well as eliminating the need for “austerity” – which has been thoroughly discredited, both economically and politically.
Of course, periodic supply shocks, especially those affecting energy, imply some residual vigilante risk. These events are bad for both growth and inflation, with the latter aggravated in the case of smaller open economies like the United Kingdom by the resulting currency weakness. Sheltered from this risk by “King Dollar,” the US faces a different problem: its pro-growth investment could be inhibited by today’s deep policy uncertainties. Still, if bad equity-market reactions can discipline the Trump administration, the US Federal Reserve can continue to support the bond (Treasury) market.
J. Bradford DeLong
“Bond vigilantes” have always been a very big deal for any government, except for those happy few with the “exorbitant privilege” of possessing a currency and issuing debt that functions as the world economy’s safe and secure asset of last resort. For normal countries, what has been true will continue to be true: the leash will remain short, and markets will not hesitate to yank it if you tread off the beaten path.
For countries with the exorbitant privilege, sovereign debt, when properly accounted for, is not so much a cost as a profit center. It is more like the deposits held at an early-modern Medici bank – where people paid to keep their money safe – and less like that of a normal debtor under the thumb of some moneylender.
But even for the exorbitantly privileged, bond vigilantes do matter at one remove, because there is always the possibility that one will lose one’s vaunted status. That can happen very quickly indeed. And once it is lost, it can be extraordinarily difficult to regain. As such, this risk – even if it seems distant – should always reside in policymakers’ peripheral vision. If you lose sight of it, you may end up like former UK Prime Minister Liz Truss.
In the fall of 2022, Truss and her chancellor of the exchequer, Kwasi Kwarteng, tempted fate with a “mini-budget” that included $50 billion in unfunded tax cuts. The bond market was having none of it, and she was defenestrated after a mere 45 days in office. By contrast, US President Bill Clinton’s administration always had the bond vigilantes in its peripheral vision, and this played no small role in the macroeconomic policy success that it achieved over the course of eight years.
Paola Subacchi
Government debt is alarmingly high. It has reached 111% of GDP across advanced economies, and 72% in developing countries. Many countries are in serious debt distress, and some have already defaulted. With interest rates relatively high, lackluster economic growth and mounting fiscal pressures will make it increasingly difficult to manage existing debts, and this will raise concerns among debt investors.
Does this signal the return of bond vigilantes? The recent spike in UK gilt yields suggests some discomfort among investors about the new Labour government’s fiscal policy. In mid-January, the 30-year gilt yield hit 5.5%, reflecting the fact that UK inflation remains notably higher than in other G7 countries. However, much of this surge reflected broader portfolio adjustments, rather than direct concerns about fiscal policy.
Even in the case of former UK Prime Minister Liz Truss’s infamous mini-budget crisis in 2022, there were mixed signals. There were certainly market concerns about the government’s plan to increase borrowing without clear funding strategies. But the crisis was exacerbated by pension funds using gilts to hedge their long-term liabilities. The sudden drop in gilt prices triggered substantial collateral calls, forcing these funds to sell more gilts and driving prices further down in a self-reinforcing cycle.
As for the US, yields remain stubbornly high. Yet this is not necessarily an unambiguous sign of investors’ dwindling confidence in US fiscal policy. Instead, it reflects the complex dynamics of US capital markets, including the large equity premium. Ultimately, US Treasuries are the world’s preeminent safe asset. No other markets for safe assets denominated in major reserve currencies offer the size and depth required to meet the massive global demand – particularly the demand for official foreign-exchange reserves. So far, this demand has been sufficiently resilient to weather the actions of disillusioned bond investors.
Desmond Lachman
Anyone doubting the strong likelihood of the bond vigilantes’ return has not been paying attention to the recent, strange developments in US ten-year Treasury bond yields (as of this writing in early February). Nor have they been paying attention to President Donald Trump’s budget-busting tax-cut proposals.
Since last September, when it became apparent to markets that Trump was likely to win the election, the ten-year Treasury yield has risen by around 100 basis points even as the Federal Reserve has cut its policy rate by the same amount (from 5.25-5.5% to 4.25-4.5%). It did so on the expectation that the US budget deficit would rise meaningfully from its already worryingly high level of around 6.5% of GDP.
According to the Committee for a Responsible Federal Budget, Trump’s tax-cut proposals would add $7.75 trillion to the US national debt over the next decade, pushing the debt-to-GDP ratio above 140% by 2034. If implemented, such massive tax cuts are bound to raise serious questions about the sustainability of US public finances, and that in turn would constitute an open invitation for the bond vigilantes to return in full force.