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The Return of Bond Vigilantes: Investors Sell Amid Higher Interest Rates and Growing Fiscal Deficit

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The Bond Vigilantes Return as Investors Sell Amidst Higher Interest Rates and Growing Fiscal Deficit

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Introduction

Investors are selling their bonds due to the prospect of higher interest rates and an increasing fiscal deficit, according to Kevin Zhao, head of global sovereign and currency at UBS Asset Management.

Rising U.S. Treasury Yields

The yield on the benchmark 10-year U.S. Treasury note rose above 5% once again on Monday, reaching a level not seen since 2007. Yields move in the opposite direction of prices.

Monetary Policy and Fiscal Slippage

Investors are reacting to Federal Reserve Chairman Jerome Powell’s commitment to tight monetary policy and the central bank’s goal of achieving sustainable inflation. Additionally, they are considering the surprising economic resilience alongside the growing fiscal deficit.

Increasing Fiscal Deficit

The U.S. federal government ended its fiscal year in September with a deficit of nearly $1.7 trillion. This adds to the existing national debt of $33.6 trillion, which has grown significantly due to the Covid-19 pandemic and the implementation of fiscal stimulus measures.

Historic Bond Market Sell-Off

Zhao referred to the bond market sell-off in response to former British Prime Minister Liz Truss’ fiscal policy decisions as an example of bond investors expressing their discontent. Bond vigilantes, as they are called, sell bonds to protest against inflationary fiscal or monetary policies.

Concerns Over Interest Rates

Market participants are evaluating the possibility of interest rates remaining high, as the Federal Reserve attempts to control inflation. Although U.S. inflation has decreased from its peak, it still remains above expectations.

Strategists’ Perspectives

Several strategists, including Zhao and Yardeni Research President Ed Yardeni, have expressed similar concerns about bond vigilantes and the impact of fiscal policy on interest rates. They believe that fiscal deficits need to be addressed to prevent adverse effects on the economy.

Significance of the 10-Year Yield

The 10-year yield is an important indicator of mortgage rates and reflects investor sentiment towards the economy. A rising yield suggests reduced demand for safe-haven Treasury bonds and a willingness to invest in higher-risk assets.

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