US and South African central banks both adopted a cautious stance last week, as they seek clarity on the impact of US President Donald Trump’s proposed policies. Bond markets, in contrast, are making their opinions clear. Bond vigilantes — who curtailed president Bill Clinton’s policy agenda in 1993 and evicted British prime minister Liz Truss in 2022 — are said to be growing “twitchy”.
There were no surprises at the US and South African monetary policy meetings last week. The Federal Reserve left interest rates unchanged at 4.25%-4.5%. The Reserve Bank’s monetary policy committee (MPC) delivered a widely anticipated 25 basis point (bp) interest rate cut, taking the benchmark repo rate down to 7.5%.
Somewhat unusually, a common theme emerged in statements released after the two meetings. They indicated a wait-and-see approach to monetary policy until there is greater clarity about the economic impact of the second Trump administration.
The Fed is trapped in “a sort of policy purgatory”, according to one analyst. Still-solid US economic growth and lingering price pressures mean it is under no pressure to cut rates. However, it appears the uncertainty caused by the torrent of executive orders from the Trump White House was what prompted the Fed to move to the sidelines.
The expected scale of US interest rate cuts this year has already been brutally pared back and, after the latest meeting, markets are discounting a total of just 45bp in interest rate cuts this year.
Back at home, Bank governor Lesetja Kganyago noted that at the previous MPC meeting, the Bank had warned about a more challenging global environment. In the weeks since, some risks had indeed materialised — notably the shift in the outlook for US monetary policy. With the space for Fed rate cuts now limited and the implications of a potential trade war unknown, the Bank decided to adopt a similar wait-and-see stance as the Fed. It also offered little guidance on the likely trajectory of rates in 2025.
At the Davos meeting of the World Economic Forum in January, Trump “demanded” lower interest rates in the US and across the world. Some major central banks have indeed continued to reduce rates. They include the European Central Bank and the Bank of Canada, due to the potentially negative consequences for their respective economic growth rates of a US tariff-induced trade war. The Bank of England (BoE) is also expected to cut interest rates at its next policy meeting.
While policy uncertainty has effectively sidelined the Fed, the bond markets have expressed concern, with the 10-year Treasury yield soaring by nearly 100bp since late September last year to 4.25% at the end of January 2025.
Bonds are loans made by an investor to governments or companies needing capital. A bond’s price moves in the opposite direction to its yield. When the price of bonds declines, the yield rises — making borrowing more expensive not just for governments, but also for companies and households.
Longtime Trump economic adviser Arthur Laffer argues that the higher bond yield is in fact a positive sign for the new administration, because it reflects expectations that Trump’s policies — notably tax cuts and deregulation — will boost growth.
The prospect of interest rates remaining higher for longer in a still-strong US economy may indeed be raising yields. But it seems the bond markets’ main concern is the potential impact of Trump’s policies on government debt — particularly since Trump has inherited far higher levels of federal debt in his second term than when he started his first in 2017.
The value of outstanding US Treasuries has risen from less than $5-trillion before the 2007/2008 global financial crisis to just below $20-trillion when Trump first came to office, and now to $28-trillion in January 2025. If left unchecked, it is estimated that within two years, the US debt-to-GDP ratio will exceed the record set after World War 2, when the government had borrowed heavily to finance the war.
Hence the growing speculation that bond vigilantes could return. This is the term for investors who, by raising the cost of borrowing, in effect impose fiscal discipline on governments perceived as fiscally reckless. Investment strategist Ed Yardeni, who coined the phrase, suggests that while bond vigilantes worried about inflation in the 1980s, this time they are concerned about the surge in government bond issuance and the resultant surge in federal debt. According to Yardeni, bond traders are growing increasingly “twitchy”.
The last US president who had to face bond vigilantes was Clinton. At the start of his first term in 1993, Clinton was forced to change policy quickly by implementing unpopular tax hikes and spending cuts. He was responding to bond market concerns over the debt levels he had inherited, after a decade of low taxes and high defence spending under presidents Ronald Reagan and George HW Bush.
Truss, the famously short-serving UK prime minister, was quickly dispatched by bond vigilantes when her unfunded tax cuts in the UK mini-budget, aimed at bolstering economic growth, caused chaos in UK debt markets in late 2022. As the pound tumbled to record lows and gilts suffered their largest single-day slump in decades, the BoE was forced to intervene.
In just more than two weeks, the BoE purchased £19.3bn of gilts, thereby stabilising the market and preventing a crisis that could have threatened the entire financial system.
Truss resigned after just 49 days in office.
Once markets lose confidence in policy, politicians can quickly lose control
Higher yields hold negative implications for the US economy as they raise the cost of government borrowing, thereby worsening already elevated levels of federal debt. But higher yields also have a negative impact on the economy generally, by raising lending rates for companies and consumers in areas such as home and car loans.
A recent Reuters review of bond vigilantism since the 1980s reveals that once markets lose confidence in policy, politicians can quickly lose control. It is possible that Trump, like Clinton, will discover that bond vigilantes can quickly make enacting his policy agenda extremely difficult, if a steep increase in interest rates triggers a financial crisis or even a recession.
However, Trump will have some cover against bond vigilantes, thanks to the dollar’s status as a global reserve currency and the Fed’s ability, as a buyer of last resort for US debt, to intervene in a crisis.
In addition, the appointment of market-friendly Scott Bessent as Trump’s treasury secretary could ensure that the net outcome of Trump’s policies is relatively fiscally conservative. The US Treasury’s announcement of his appointment notes that Bessent “has been in the global investment management business for 40 years” and is “regarded as a currency and fixed income specialist”. He has worked as chief investment officer and managing partner of Soros Fund Management.
Encouragingly, Bessent noted during his confirmation hearings that the federal government has a significant spending problem and that the high deficit means there is little capacity to borrow heavily in the event of a crisis.
What remains unclear is what exactly could trigger a bond market sell-off. It is widely accepted that once panic sets in, the situation could quickly spiral out of control, needing significant intervention to restore stability.
As a market analyst noted, if there is a confrontation between the ruling populists and the bond vigilantes, one can only hope the Trump administration receives a “strong nudge” rather than the disastrous “hard shove” received by Truss in 2022.
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