Bond Vigilante Definition

Bond Vigilante

Investopedia / Julie Bang

What Is a Bond Vigilante?

A bond vigilante is a bond trader who threatens to sell, or actually sells, a large amount of bonds to protest or signal distaste with policies of the issuer. Selling bonds depresses their prices, pushing interest rates up and making it more costly for the issuer to borrow.

The term was coined by investor Ed Yardeni in the 1980s when bond traders sold Treasurys in response to the growing power of the Federal Reserve and its policies on the U.S. economy.

Key Takeaways

  • A bond vigilante is a fixed-income trader who sells bonds, or threatens to do so, to push back against certain policies undertaken by the issuer.
  • The term was first coined in the 1980s in reference to bond traders protesting the Federal Reserve’s dovish monetary policy at the time.
  • Bond vigilantism demonstrates that market actors, and especially bondholders, have large influence that they can exert (or threaten to exert) over borrowers.
  • This practice was diminished by central bank efforts following the Great Recession, but it may have returned in response to rising inflation since mid-2022.

Understanding Bond Vigilantes

The yields on bonds represent the interest rate at which issuers can borrow from investors. Interest rates also have a negative correlation with bond prices: As yields rise, bond prices fall. The same association, however, also works if the price of the bonds falls first—yields are forced to rise in turn.

Because of this fundamental relationship, an aggressive seller among bondholders can raise the costs of borrowing for future issues. That's because selling their bonds at ever-lower prices effectively raises the interest rates an issuer must pay out for subsequent bonds. While this has no impact on a bondholder that carries previously purchased bonds to maturity, this action has the potential to seriously inconvenience the issuer. Such a seller typically hopes to punish the issuer for pursuing certain actions or policies.

For example, during a period of rising inflation in the early 1980s, the Fed initially remained quite dovish, leaving rates largely alone. Bond vigilantes, however, soon emerged to protest this policy, as they believed that rates needed to be much higher to curb inflationary pressures. Selling government bonds en masse in this way did ultimately raise rates in the market, and the Fed soon followed suit and shifted to a more hawkish stance.

Bond vigilantism demonstrates that market actors, and especially bondholders, have significant influence that they can exert (or threaten to exert) over borrowers.

Episodes of Bond Vigilantism

As mentioned, investment strategist Ed Yardeni came up with the term “bond vigilante” to describe the actions of large bond traders in the Treasurys market. During the 1980s' inflation, he stated that “even before the Fed really started to aggressively raise interest rates, the bond vigilantes figured it out and kind of jumped ahead of the line and pushed interest rates up dramatically.”

In the early 1990s, bond traders became frustrated with the massive government spending that initially occurred under the Clinton administration, driving yields on 10-year Treasurys up from around 5% to 8% over the course of a year. Once policy changed to reduce the deficit, yields once again dropped.

Following the 2008 financial crisis, several European economies—primarily the so-called PIIGS countries of Portugal, Ireland, Italy, Greece, and Spain—found themselves in a debt crisis. Recognizing the massive amounts of liabilities due, yields on sovereign debt in these countries exploded. As Yardeni notes, “When those Greek bond yields went up to 40%, they were clearly screaming that something was just dead wrong with the way that country was being run, and things changed and those bond yields came down.” Still, some blame bond vigilantes for making it more difficult for these countries to recover because the bond vigilantes pushed yields up so high that it made it expensive to borrow—and ultimately to function properly.

Some experts believe that bond vigilantes have returned, beginning in mid-2022, in response to the Fed’s slow response to rapidly rising inflation.

Bond Vigilantes vs. Activist Investors

Bond vigilantes show that markets and large market actors can greatly influence the behavior of the issuers of securities in which they trade.

Another example of this concept is that of activist investors. These are large shareholders who accumulate enough of an equity stake to force changes in corporate management and direction. These activists are able to accumulate enough voting rights as shareholders to gain board of director seats and replace corporate managers like the CEO. They may also threaten to sell their shares in the market, pushing down the price of the stock and lowering the market value of the company (known as "the power of exit").

Who or What Is an Example of a Bond Vigilante?

One example of a bond vigilante is PIMCO, a bond fund with nearly $2 trillion in assets. Under ex-manager Bill Gross, PIMCO famously divested from U.S. government bonds because Gross felt that the government’s spending deficit could not be solved.

What Happened to the Bond Vigilantes?

Since the mid-2000s, bond vigilantes have been stymied by the efforts of central banks to keep interest rates very low, especially following the Great Recession. The use of measures like quantitative easing (QE) made it difficult for the mere act of selling bonds to have a significant influence on bond yields. As of mid-2022, however, the vigilantes may have returned as a harbinger of central banks’ slow response to rising inflation around the world.

How Does Selling Bonds Make Borrowing Costs Go Up?

Bond prices and interest rates are inversely related—when interest rates (yields) go up, bond prices go down. But when bond prices rise, yields fall. Selling bonds depresses their prices, pushing interest rates up and making it more costly for the issuer to borrow.

The Bottom Line

Bond vigilantes use their power as large bondholders to influence the behavior of bond issuers, whether corporations or governments. By moving bond markets, these large market actors can greatly increase the cost of borrowing for issuers as a form of discipline or punishment for perceived mismanagement or policy missteps. Coined by Ed Yardeni in the 1980s, the term "bond vigilante" has now become synonymous with bond market activism.

Article Sources
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  1. Yardeni Research. “The Bond Vigilantes.”

  2. Bloomberg, via Internet Archive. “Bond Vigilantes Confront Obama as Housing Falters.”

  3. Forbes. “The Bond Market Vigilantes Are Back, Overriding the Federal Reserve ‘Go Slow’ Policy.”

  4. The Atlantic. “The Vigilante.”

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