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Two weeks ago, when the January jobs report showed wage gains up 2.9% from a year ago, triggering inflation fears, the bond market freaked out and stocks started tanking.
That's behind us now. Or is it?
Sure, stocks have recovered and the 10-year Treasury yield is lower, but inflation fears are still out there – and that means bond vigilantes are lurking in the shadows and could hijack markets again.
Here's the truth about inflation, the origin of these bond vigilantes, and how the market will react to all of this…
The Great Bond Massacre
Bond vigilantes are Treasury bond market investors and traders who protest monetary or fiscal policies they consider inflationary by selling and shorting Treasury bonds, which increases their yields.
They're vigilantes because they theoretically act as a restraint on the government's ability to overspend and overborrow by raising borrowing costs as they push interest rates higher.
The term first originated in 1993 during the Clinton administration, when bond sellers pushed U.S. 10-year yields from 5.2% to just above 8.0% over market concerns about federal spending.
That sell-off became known as the "Great Bond Massacre."
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Starting last September, with U.S. GDP growth already expected to pick up, new bond vigilantes began selling Treasuries anticipating that massive tax cuts and the president's push for infrastructure spending would stimulate the economy above trend and spark inflation.
From just above 2% in September last year, 10-year yields spiked to 2.85%. When higher-than-expected wage gains numbers came out two weeks ago, the 10-year yield shot up to 2.95%, a four-year high, triggering an across-the-board stock market sell-off.
Now, with stocks having recovered three-quarters of their losses and the 10-year Treasury yield back down to 2.84%, stock and bond investors seem to think inflation fears are overblown.
It's Called the "Amazon Effect"
Treasury Secretary Steven Mnuchin weighed in last week on what he considers overblown fears, saying "there are a lot of ways to have the economy grow… You can have wage inflation and not necessarily have inflation concerns in general."
For the most part, he's right.
While the unexpected uptick in wage gains is an inflationary additive, gains aren't necessarily sustainable, and other inflation measures remain at bay, for the time being.
The rate of inflation, using the Fed's preferred PCE index (Personal Consumption Expenditures Price Index), rose to 1.7% last year from 1.2% in 2015. It was just 0.3% in 2014.
However, the CPI (consumer price index), which analysts say better reflects what Americans pay for goods and services, was running at a 2.1% rate at the end of 2017.
That's not a big deal. The Fed's been trying to get inflation up to a 2% level for years now. If we're there based on the CPI, that shouldn't surprise anyone. In fact, it should be healthy.
The fact is it's been a decade since inflation reached 3%, a level that would be concerning. We're nowhere near that and probably won't get there for a long time to come.
Lots of factors are dampening inflation and wage inflation in particular, including a huge move toward automation, global competition, and online shopping – with its price comparison advantage, or "Amazon effect."
Customers can see prices from all over the world, making it harder for companies to raise prices and make them stick.
With no real inflation immediately in front of us, or out in the future, it doesn't make sense that bond vigilantes would be selling bonds causing yields to spike.
But they did and may well start doing so again.
About the Author
Shah Gilani is the Event Trading Specialist for Money Map Press. In Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains.Shah is also the proud founding editor of The Money Zone, where after eight years of development and 11 years of backtesting he has found the edge over stocks, giving his members the opportunity to rake in potential double, triple, or even quadruple-digit profits weekly with just a few quick steps. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.