What is... | January 6, 2011

What is a bond vigilante?

In the wider world, a vigilante is commonly seen as a heroic figure that protects the helpless when police are absent. In financial markets, the term “bond vigilante” has a different – but related and highly relevant – meaning.

The term “bond vigilante” – coined by United States investment strategist Ed Yardeni in 1983 – describes how markets act to safeguard the economy when governments and central banks have not.
Fears in years past that European countries (such as Ireland and Greece) may not be able to pay the interest on their sovereign bonds have prompted “bond vigilantes” to push bond yields up and lower bond prices in these countries. 

Vigilant vigilantes
Bond vigilantes tend to be institutional investors who hold bonds in a country or a company. Typically, they have determined that debt levels in the country or the company are too high and either sell their bonds or chose to not reinvest when the debts are refinanced. More active investors may deliberately sell the debt even though they do not own it (known as going short) in an attempt to make a profit. Such actions push up borrowing costs for the country or company and ultimately reduce their borrowing – forcing a safeguard against excessive borrowing and debt. While it might sound selfless, the motivations of these bond vigilantes vary – with some simply trying to avoid taking a financial loss.

Vigilantes in action
Circumstances in the second half of 2010 suggested bond vigilantes had been at work. Ireland and Greece, for example, saw interest rates for government borrowing rise much more quickly than the rises for interest rates for government borrowing in other European nations (such as France and Germany). It is difficult to know with certainty the financial flows – whether bonds were sold short or simply not refinanced – that led to the marked rise in bond yields for these countries. But signals (such as very high levels of debt in Ireland and Greece) made it likely so-called bond vigilantes took action.

Not so solid bond
The eZonomics video How bonds work tells how bonds are like a formal IOU and how some investors see bonds as a “safe” investment. But investors can see the value of the bonds they hold fall sharply, particularly in the type of stressed circumstances in which bond vigilantes operate. It is a reminder than no investment is risk-free.

Weighing the risks
In line with the lifecycle approach to investing, the risk profile of bonds may make them a fitting investment for investors approaching retirement. But investors should not assume bonds are risk-free.


Phil Thornton
Phil Thornton

Lead consultant at Clariti Economics