Return of the bond vigilantes and the spectre of an American face-off
By Kara Lilly and Michael Kosmalski
It started, as these things often do, with a shift too small to notice. One moment, the gilts market was stable. The next, it wasn’t.
A few months ago, a troubling development unfolded in the United Kingdom that spooked Brits, rattled bond desks globally and was largely ignored by everyone else. While United States President Donald Trump commanded the spotlight with a flurry of policy proposals, the yield on 30-year U.K. government bonds (gilts) surged past five per cent.
Now, by nature, bonds are tedious. Studying them tends to make your eyes glaze over. But these were serious moves: yields climbing to their highest levels since 1998, while the pound sterling fell.
Together, these swings raised a pointed question: were bond vigilantes back?
What are bond vigilantes? The term refers to investors who sell off bonds in response to fiscal policies they see as reckless, driving up yields and borrowing costs to enforce discipline. Economist Ed Yardeni coined the term in the 1980s.
A famous episode followed from late 1993 to 1994, when 10-year U.S. Treasury yields rose to more than eight per cent from 5.2 per cent, spooking the administration and prompting deficit-reducing measures. By 1998, yields had fallen to around four per cent.
Bond markets wield power because they’re a country’s credit lifeline. Without affordable credit, governments struggle to function and economies can’t grow. Few forces have shaped history more than the bond market.
For example, in the 19th century, Italy’s unification was partly enabled by Count Camillo di Cavour, prime minister of Piedmont-Sardinia, who secured funding through international bond markets.
More recently, Argentina’s economy collapsed after years of borrowing and a failed currency peg. Investor confidence evaporated, yields spiked, the country defaulted on US$100 billion, and the president fled amid riots.
And you likely know the story of 18th-century France, if not the bond market’s role in it. France, drowning in debt from decades of war, including its costly American Revolution involvement, tried issuing more bonds. Investors balked. Yields soared. The monarchy couldn’t raise funds.
King Louis XVI was forced to convene the Estates-General in 1789, triggering events that ended in revolution, the infamous phrase “Let them eat cake” and the monarchy literally losing its head.
“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter,” James Carville, a political adviser to president Bill Clinton, once quipped. “But now I would like to come back as the bond market. You can intimidate everybody.”
Bond vigilantes bring a loaded weapon when they show up to the duel.
In the first quarter this year, it looked like they were back, protesting what many saw as fiscal carelessness in the U.K. Yields spiked. The pound fell. Within days, Finance Minister Rachel Reeves was reaffirming fiscal discipline and markets calmed.
But a few weeks later, a more muted version played out in Germany after Chancellor Merz proposed big defence and infrastructure spending beyond typical debt limits. Yields ticked up.
Three observations are appropriate to make now. First, bond vigilantes appear to have finally arisen from their long nap.
Second, despite the profligate manner in which governments worldwide have spent and accrued debt over the last few decades, there remains some upper limit on how much fiscal mess bond investors are willing to bankroll.
Third, it may be time to ponder the question many investors have actively avoided because it is such a headache to consider.
What if bond vigilantes come for the U.S.?
Many investors avoid this question. America, they argue, is America, the world’s strongest economy and issuer of the reserve currency. It won’t be easily dislodged. Besides, if the dollar fell and yields soared, the fallout would be too incomprehensible to imagine.
But low odds aren’t the same as an impossibility, and scenarios being potentially painful is the best reason to confront them. Today, there are three reasons this one deserves attention.
First, America’s fiscal position has long been poor and it’s gotten worse.
Second, many of Trump’s policies — including sweeping tariffs, floating a debt restructuring, and the proposed tax legislation advancing through Congress, which could add US$1 trillion to US$2 trillion to the federal deficit over the next decade — look likely to worsen the fiscal outlook and/or rattle bond investors.
Third, bond markets have been acting odd lately. With all the uncertainty and volatility in stocks, this should be a clear “safe haven” moment. Instead, U.S. Treasuries are selling off.
All this is raising the odds of something unwanted: a bond vigilante showdown.
An American standoff with vigilantes could be either performative or nasty. The consequences — to Americans, to markets, to the world — would depend heavily on which one unfolds.
A nasty clash would resemble the British experience, but with U.S. leadership refusing to back down. This would be the “let them eat cake” moment: yields would spike, the administration would inadequately respond, bondholders would lose even more confidence, yields would spike further, the dollar would fall, thereby spooking everyone now actively paying attention and a full-blown crisis would eventually be on everyone’s hands.
This scenario is a bit like the asteroid that NASA recently detected as being on a low-probability collision course with Earth (for a while there, they were giving this a three per cent chance). Those are low odds, but seriously destructive should it occur.
More likely is a performative standoff, echoing the 1990s’ Clinton era. Vigilantes call the administration’s bluff. The administration, unwilling to play chicken, would back down and implement the fiscal changes needed to restore confidence.
Yes, even Trump would be forced to yield.
Markets would reel — bonds and equities alike — but ultimately stabilize. The world would move on, bruised but intact.
Of course, a standoff could be avoided altogether if politicians prioritized long-term national interests over short-term personal gain. Your guess is as good as anyone’s on how likely this is.
For investors, recent events are a warning that market forces can, and do, exert control when governments push too far with excess. Bond vigilantes appear to be back, or at least, circling on the sidelines.
As Trump and his administration walk the fiscal tightrope, it may be bond vigilantes — quiet, often overlooked — who decide America’s financial fate. People obsess over stocks. History shows, however, the bond market is the ultimate check on power.
It is the real kingmaker.