Dow Jones Reprints: This copy is for your personal, non-commerical use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool on any article or visit www.djreprints.com
THE BOND VIGILANTES ARE BACK and they've restored some disinflationary order.
Bond yield have shot up in almost unprecedented fashion since the Federal Reserve announced its plan to purchase $600 billion of Treasury securities two weeks ago—precisely the opposite effect the monetary authorities intended from QE2, the second phase of its quantitative easing.
From a low of 2.48% on Nov. 4, the day after the announcement of launch of QE2 by the Fed, the 10-year note yield began to rise and then shot up in the past week, to a peak of 2.96% Monday, amid a barrage of withering criticism that was largely political in nature.
"The Fed decision drew criticisms from many parties that share little in common, people within the Federal Reserve, the Republicans, the Tea Party, Germans and Chinese," writes Bin Gao, rate strategist for Bank of America Merrill Lynch.
In addition, some 23 luminaries in the political, financial and economic spheres signed a letter calling on Fed Chairman Ben Bernanke to reconsider and discontinue QE2, which appeared as a full-page advertisement in Tuesday's Wall Street Journal. Central-bank officials, clearly back on their heels, were forced to counter these verbal assaults. Both Vice Chairman Janet Yellen and New York Fed President William Dudley in separate interviews denied QE2 would debase the dollar and lead to an unwanted surge in inflation.
Against the backdrop of this uncharacteristic criticism of the U.S. central bank—and equally uncharacteristic defensiveness on the part of the Fed—the bond market had been in virtual freefall. The sharp, nearly-half-point rise in yields translated into steep price losses of 6% for the iShares Barclays 20+ Year Treasury Bond exchange traded fund (TLT), a popular way to participate in the long end of the market. That would equal to nearly a 700-point drop in the Dow Jones Industrial Average, or 200 points more than the Blue Chip gauge's actual decline from its peak only a week and a half ago.
Yet, for all the inflation hysteria provoked by QE2, the bond market's severe back-up in the past couple of weeks reflected something else all together—a leap in "real" interest rates, that is, the level after deducting expected inflation. This perceptive observation comes from James O'Sullivan, chief economist at MF Global.
The real yield comes from the 10-year Treasury Inflation Protected Securities yield, which has risen even faster than the nominal note's yield. The difference between the TIP and the nominal yield is the "break-even" inflation forecast derived from the market, and that's actually rolled over as the rhetoric about the Fed's policy has heated up.
Tuesday saw a marked reversal. Treasury bonds rallied and yields tumbled amid a sharp sell-off in risk assets, notably stocks and commodities. U.S. equities slid 1.6% while metals prices fell 5% and crude oil dipped 3%. Gold, meanwhile, has lost about $85 an ounce since its peak just last week, to $1335, hardly inflationary action.
So, the long-complacent bond vigilantes appear to have pushed up real yields sufficiently to exert deflationary pressures on equities and commodities and effectively deflated the alleged inflationary effect of QE2. Anybody thinking of trying to pick the bottom in mortgage rates to refinance now may want to rethink their plans.
To be sure, the vigilantes had help, notably the Chinese, which actually face a clear and present inflation problem that will likely result in further interest-rate hikes.
The European sovereign debt crisis continues to deepen as the EU appears to be preparing a bailout for Ireland, whether it wants one or not.
Elsewhere, some emerging markets economies are talking about imposing capital controls to contain the upward pressures on their currencies. That would obviate the need for their central banks to sell their currencies and buy dollars to stabilize exchange rates, which would curb the growth of their money supplies.
From the rise in bond yields to the European crisis to the threat of EM capital controls, each disparate development is disinflationary. So, these market forces are thwarting the Fed's expansionary efforts. In other words, Bernanke & Co. seem no match for the bond vigilantes.
Comments? E-mail: randall.forsyth@barrons.com
This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com
Yahoo! Buzz
MySpace
Digg
del.icio.us
NewsVine
StumbleUpon
Mixx
New 13F filings reveal the latest moves by star investors David Tepper, John Paulson and Warren Buffett.
Saks targets luxury shoppers while TJX caters to bargain-hunters. See which is the better investment.
Urban Outfitters and Dick's Sporting rose. Regions Financial and Mela fell.
Lennar and DR Horton generally turned in the best quarterly metrics.
Though "moderately optimistic" about stocks, an S&P market strategist expects to see some profit-taking in the near term.
The investment manager is suffering from lagging equity flows.
Credit Suisse likes Zions, Bank of Hawaii, Valley National and M&T.
The satellite-radio firm will continue seeing positive momentum.
Despite recent gains, shares of the lab-equipment company still look unappreciated.
The home improvement retailer's third-quarter was mixed but the stock is priced to buy.
Broadcom and Skyworks are seen as picks in handsets.
The videogame retailer is set for a strong holiday season.
Credit Suisse lowered earnings-per-share on several smaller U.S. banks.
Though quarterly results were leaked prematurely, it's not premature to expect the stock to keep its magic.
Following Caterpillar's bid for Bucyrus, here are three more bargains. (At SmartMoney.com.)
Exchange-traded funds are having a huge impact on the markets. How they can help investors. How they can hurt them.
Inflation in China and a slowdown in Germany may be twin omens of hard times. Plus, a chilly G-20 greeting for President Obama.
With almost $1 trillion in assets, exchange-traded funds have become a force in the markets. Barron's is expanding its coverage of them.
Drug maker Novartis is due to lose key patents, and it is struggling to complete its purchase of eye-care star Alcon, but its shares are still cheap.
Private-equity firms aim to take the debt-laden casino operator public after its 2008 leveraged buyout. Prospective buyers should think twice before betting on the shares.
China's iron-ore hunger is driving profit gains at Vale, the Brazilian producer. Shareholders, too, could win as demand for base metals outstrips supply.
Options traders are betting on a sustained rally in stocks as the Federal Reserve embarks on a new round of quantitative easing.
Read Full Article »