The story is that the bond market forced President Bill Clinton to change his budget plans. Bob Rubin, director of the newly created National Economic Council, supposedly convinced Clinton that those who buy and sell Treasury securities on Wall Street would force interest rates much higher and hurt the economy if he didnt do something about the deficit and federal borrowing.
The anonymous traders were dubbed bond market vigilantes (a phrase coined by economist Ed Yardeni a decade or so earlier) because they were more than willing to use the weapon at their disposal higher interest rates to force fiscal policy in their preferred direction.
Its clear that the bond market is now giving at least as strong a signal about its desired fiscal policy as it did in the early 1990s. But instead of demanding reductions in the deficit and government borrowing and threatening higher interest rates if those dont happen, todays vigilantes are unmistakably saying just the opposite. They want Washington to do more to stimulate the economy, and they welcome the deficit and debt it will take to do it.
In other words, the former bond market vigilantes have now become the biggest supporters of federal deficits and borrowing. Ill follow in Yardenis footsteps and call them bond market deficit cheerleaders.
Its almost impossible not to notice how unambiguously the bond market deficit cheerleaders are making their policy preferences known. In spite of the repeated prognostications made by multiple commentators that interest rates will (rather than could) rise in response to the large deficits because of bond market disgust, traders have voted with their dollars. The auctions of Treasury securities that were needed to finance borrowing have almost all demonstrated a strong demand for federal debt over the past year, no matter what the maturity. As a result, interest rates have remained low or fallen. This is especially the case with long-term rates, which would be the ones most affected by concerns about budget-related federal borrowing and inflation. The bond market deficit cheerleaders have shown little indication theyre concerned.
There are some technical and non-fiscal-policy-related reasons for the high demand for Treasury securities. For example, its become clear that banks are parking some of their excess reserves in Treasuries, rather than increasing lending during what they consider to be an uncertain economy. In the process, they are pushing interest rates lower.
The volatility in the stock market has also pushed some investors to allocate more of their funds to cash and cash-equivalents like Treasury securities. In addition, overseas demand for federal securities has been high because U.S. bonds are still considered the safest haven in the wake of concerns about the fiscal stability of Greece, Spain and other countries.