“The [Bond Market] is not as forgiving as I am”
– (Paraphrased from “The Emperor is not as forgiving as I am,” a quote from Darth Vader in “Return of the Jedi,” 1983)
By Scott Welch, CIMA®, CEPA®, Chief Investment Officer & Partner
Reviewed by Carter Mecham, CMA®, IACCP®
We have been in this business long enough to remember when, while working on a global bank trading floor, no one much cared about announcements from the Fed – they were just background noise to the ongoing execution of active bond trading.
The term “bond vigilantes” was coined in the 1980s by economist Ed Yardeni and referred to professional bond traders who bought and sold Treasury bonds to signal to the market what they thought about current fiscal and monetary policy. In particular, they were known for selling large volumes of Treasury bonds to protest what they viewed as inflationary monetary policies.
But when Ben Bernanke became the Fed Chair in 2006, he introduced the notions of “Zero Interest Rate Policy” (“ZIRP”) and “forward guidance”, by which the Fed would signal without stating explicitly what it was considering in terms of future rate policies. These policies were intended to keep short-term rates low and predictable.
“Quantitative Easing (QE),” whereby the Fed purchased large volumes of long-term government bonds, was also part of overall Fed policy, in an attempt to influence the long end of the yield curve as well.
The purpose of these policies was to keep interest rates low and minimize bond market volatility in order to stimulate economic growth.
The long-term economic success of those policies can be debated but they certainly did escort in a decade or more of low bond market volatility.
In the following chart, note the relative quiescence of the MOVE index (a measure of bond market volatility) between the end of the Great Financial Crisis (GFC) in early 2009 and the COVID pandemic era of 2020-2022.
Source: TradingView, data through August 3, 2026. The BofAML “MOVE” index tracks the implied volatility in U.S. Treasury yields using the prices of one-month, over-the-counter options on key Treasury maturities: 2-year, 5-year, 10-year, and 30-year bonds. You cannot invest in an index, and past performance is no guarantee of future results.
This low volatility also resulted in the “hibernation” of the bond vigilantes. With the Fed exerting so much influence on the level and shape of the yield curve, what was there for bond traders to do?
But, as with most aspects of the capital markets, no “regime” lasts forever, and we seem to be evolving back into a bond market where the market itself, and not the Fed, is once again exerting more influence on the level and shape of the yield curve and credit spreads.
New Fed Chair Kevin Warsh has made this an explicit goal of his tenure as Chair. He refuses to offer forward guidance in his media appearances (though he cannot prevent other Fed Governors from weighing in publicly), and he made it clear he wants “the market” to dictate rate and trading decisions.
Here is a compilation of some of his comments at various press conferences and Congressional hearings:
“Forward guidance is not the business we should be in…
Financial market prices are probably the most important source of information to guide central bankers. But when all the financial markets are doing is reflecting back what we’ve [the Fed] said, then we’re taking the most important source of information, and we’re being blind to it…
I believe that price stability should be a change in prices such that no one’s talking about it…
I am pleased to report that members of the FOMC are unambiguous and unanimous: This Committee will deliver price stability.”
So, does this new “back to the future” Fed regime suggest a “Return of the Bond Vigilantes”?
Let’s dive in.
We Need to Start with the Fed’s Dual Mandate of Managing Employment and Inflation
Before we tackle the yield curve and the bond vigilantes, we should remind ourselves of the Fed’s dual mandate of maximizing employment while maintaining price stability (which translates into a target annualized inflation rate of 2%).
We covered this extensively in our recent three-part series of “What Moves the Fed,” but it is worth taking a quick look at the current state of affairs.
First the labor market. A 5% unemployment rate historically was considered a “full employment” economy. We have now been below that level for almost five years, going back to the tail end of the COVID era.
Source: St. Louis Fed (FRED), 5-year data through June 2026. The gap in the charts are due to the government shutdown in the fall of 2025.
Looking at the most contemporaneous metrics of employment – the initial and continuing unemployment claims – we see that both are trending downward, illustrating continued resilience in the current labor market. We focus on the 4-week moving averages of these metrics to smooth out weekly volatility (the pink lines in the following two charts).
Source for both charts: The Daily Shot, as of August 14, 2026. Data through August 8 and 1, 2026, respectively
We now turn to inflation, and it is here we see the “sticking point” for the Fed as it contemplates future rate policy.
Through the end of June, the “headline” metrics of CPI, CPI ex-Food and Energy, and Personal Consumption Expenditures (PCE – the Fed’s preferred metric because it allows for the substitution of goods by consumers as prices change), all remain above the Fed’s target rate of 2%, though they do seem to be trending in the right direction.
Source: St. Louis Fed (FRED), 5-year data through June 2026.
The wild card in this environment is the war in Iran, which continues with ongoing stops and starts. This is causing volatility in global oil (and other commodity/resource) prices, and the Fed is trying to determine if this will result in “transitory” or “sticky” higher inflation.
Sources: TradingEconomics and the US Energy Information Administration, as of August 14, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
What is Happening at the Short End of the Yield Curve?
The Fed has multiple tools it can use to heavily influence the short end of the yield curve (maturities of two years and less). This includes:
- Setting the interest rate on reserves that banks hold at the central bank,
- Engaging in “overnight reverse purchase agreements,” which is selling securities with an agreement to repurchase them the next day,
- Setting the “discount rate,” which is the rate at which banks can borrow from the Fed’s discount window,
- “Open Market Operations,” whereby the Fed buys or sells Treasury and other authorized securities to influence the supply of reserve balances, and
- The “Term Deposit Facility,” which allows banks to place funds at the Fed for a fixed term while earning interest.
This suggests the market is either pricing in the expectation of or the desire for a rate hike from the Fed sometime before year-end (analysts are mixed as to when that might happen – the market is currently pricing in above a 50% probability of a hike in September unless the inflation data continues to come in positively – second and third charts).
Source: Ycharts, as of August 17, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Source: Atlanta Fed “Market Probability Tracker,” as of August 17, 2026. This is an estimate and subject to change as additional data come in.
Source: Daily Shot, as of August 13, 2026. This is a forecast and subject to change as additional data come in. A “negative 1” reading indicates the expectation of a rate hike.
What About the Long End of the Yield Curve?
While the Fed has a higher level of control over the short end of the yield curve, the market itself exerts much more influence over the longer end, especially as the Fed has halted its attempts to influence the long end through “quantitative easing” measures.
It is here that we may be seeing the return of the bond vigilantes. If we focus on the ten- and 30-year Treasury yields, we see relatively steady increases since the beginning of the year.
Source: YTD data through August 14, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Furthermore, we can see that rising long-term rates is not just a US phenomenon – it is global.
Source: John Authers and Bloomberg Daily Markets, as of August 18, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
We believe there are three primary reasons for this upward trend in longer term US rates:
- Inflation fears. As we discussed above, the market remains uncertain about the long-term impact of the Iran war on oil prices and inflation. The longer the war goes on (and we suspect it will go on longer than the Administration is claiming), the more embedded higher inflation expectations will be priced into the yield curve. This may affect the short end of the curve as well as it may influence the Fed’s policy decisions as we move through the remainder of 2026 and into 2027.
- The government debt and deficit. This is a longer-term issue, but the financial media are increasingly commenting on our growing levels of federal debt and deficits (as percentages of GDP).
President Trump is a real estate developer by experience and temperament, and in neither of his two terms in office has he shown any concern whatever regarding our national debt and deficit levels. His policies consistently promote short-term economic growth without regard to the federal debt situations.
It is true that this is not a new problem, and the market has essentially ignored it for decades. But as debt (left Y-axis in the chart below) and the deficit (right Y-axis in the chart below) as percentages of GDP illustrate, the problem is getting worse, and a day of reckoning will eventually come.
The current Federal debt has grown to roughly 120% of GDP over the past 10-12 years, and the annual deficit is now almost 106% of GDP.
This can only be paid down by faster growth or higher taxes (both of which are uncertain) or by issuing an increasing level of government debt.
The bond vigilantes may already be pricing in that issuing more debt will be the most expedient path forward.
Source: St. Louis Fed (FRED), data from January 1970 through Q1, 2026. The Federal Debt as a % of GDP is measured on the left Y-axis, and the Federal Deficit as a % of GDP is measured on the right Y-axis.
One example of the market taking note of increasing federal debt levels is the result of the most recent auction of 30-year Treasury bonds. For the first time since 2001 – twenty-five years ago – bond investors demanded coupons above 5% to invest in the auctioned bonds.
We have been in the market long enough to remember when 5% was considered “normal” for the 10-year Treasury (the 30-year was even higher), so an absolute level of 5% on the 30-year does not overly concern us, but it certainly marks a dramatic increase from where rates have been over the past fifteen years and may present challenges for corporations that will need to refinance currently outstanding low rate debt.
Sources: The US Treasury and The Daily Shot, as of August 14, 2026.
- The massive debt issuance of hyperscalers and AI-related companies. The “AI War” is on, and companies are committing to raising billions, if not trillions of dollars in debt to finance the build out of data centers and computational power.
M&G Investments estimates that there is already $1.2 trillion in outstanding AI-related debt. Morgan Stanley further estimates cumulative AI-related capital expenditures (“CapEx”) to reach roughly $2.9 trillion, whereas the cumulative hyperscaler free cash flow is “only” $1.4 trillion. This leaves a “funding gap” of $1.5 trillion.
As we summarized in our most recent blog on earnings, this level of CapEx cannot be met by company free cash flows.
Source: John Authers and Bloomberg Daily Markets, as of July 28, 2026.
Source for the previous two charts: Torsten Slok, Apollo, as of July 29, 2026. These are estimates and subject to change.
You can see this playing out with investors in the increasing spreads demanded for both investment grade (IG) and high yield (HY) hyperscaler versus non-hyperscaler debt.
The majority of hyperscaler debt is investment grade, so the spread differential is not as noticeable in the HY market.
Source: Penn Mutual Asset Management, as of August 6, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
The following chart needs to be interpreted carefully. While the spreads for hyperscaler debt are widening, the absolute level of difference versus non-hyperscaler industrial bond debt remains fairly tight.
At the time this chart was generated (late January of this year) the hyperscaler spreads were approximately 50-55 bps over Treasuries (the left y-axis), while the non-hyperscaler industrial bond credit spreads were roughly 65 bps over Treasuries.
In other words, the hyperscalers (most of which have outstanding credit ratings) are still issuing debt at lower spreads than non-hyperscaler industrial companies, but as they continue to come to market, investors are demanding ever-higher spreads.
Source: Torsten Slok and the Apollo Academy, as of January 21, 2026. You cannot invest in an index, and past performance is no guarantee of future results.
Summary and Interpretation
We believe it is appropriate to say the “bond vigilantes” have returned, even if they perhaps do not have the same level of influence (yet) as they did back before the era of ZIRP, QE, and forward guidance.
But Fed Chair Warsh has made clear he disapproves of forward guidance, he wants to “clean up” the Fed’s balance sheet, and he very much wants the market to determine what happens to yields and spreads.
In other words, he wants traders and investors to examine and analyze actual economic data and make determinations as to appropriate levels of yields and spreads.
We may be in the contrarian camp, but we believe this is both healthy and appropriate for more transparent capital markets.
Investors may complain (actually, are complaining) that it is harder to make investment decisions in the absence of forward guidance, but we believe the higher level of Fed intervention and guidance with respect to rates and policy was distorting the market and intrusively affecting investment decisions.
We believe the market will simply have to adjust to this “back to the future” environment, and we believe that is a good thing.
We would much rather have professional traders and investors making markets than a sheltered group of academic economists, whose collective track record has proven to be fairly abysmal.
As always, we welcome your questions and feedback.