Bond Vigilantes Of Yore Cowed by Central Banks

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Have the fearsome bond vigilantes been rendered obsolete by central banks?

As Congress and President Barack Obama lurch from one crisis to the next in an era of record budget deficits and a debt load flirting above $16 trillion, this once feared group of investors has gone strangely silent.

Bond vigilantes were credited with forcing up Treasury bond yields to just over eight percent, pressing the Clinton administration to confront the U.S. budget deficit in protest of fiscal and monetary policy. These same bond scourges helped bring Europe's debt crisis to a boiling point, by sending yields in Greece, Italy, Portugal and Spain through the roof.

Some market observers are perplexed by the reasons why the vigilantes haven't come out of hibernation. Yet others point the finger at the Federal Reserve and their global central banking cohorts, who are trying to keep the global economy afloat though massive quantitative easing.

"The vigilantes have been superseded by the Fed," Bill Gross, Pimco's bond guru told CNBC this week. Gross – who once warned bonds could be "burned to a crisp", famously exited all government-related debt positions in February 2011.

"The Fed buys, believe it or not, 80 percent of everything the Treasury issues right now. They're buying $1 trillion worth of bonds and mortgages a year," he said. "What can the vigilantes do relative to the Fed? There are hardly any bonds for the vigilantes to buy."

The world's most influential central bank is far from alone in this regard. Even through the running U.S. fiscal dramas of the last two years, foreigners have feasted on a steady diet of Treasuries, mainly for foreign exchange reasons.

According to the latest Treasury International Capital report, Japan and China are the two largest buyers of long-term U.S. government paper. Tokyo is committed to depressing the yen, and uses Treasuries to help pad its FX reserves; Beijing, meanwhile, is a big buyer of U.S. bonds as part of its strategy of pegging its currency, the yuan, to the dollar.

As a result, bond investors' "hands are forced," said Anthem Blanchard, CEO of Blanchard Vault, a retail gold and silver supplier. "U.S. agency debt and Treasury debt is the only market that's liquid, all other countries around the world trying to devalue their currencies."

The cycle of central bank buying has helped depress long-term Treasury yields at near record lows around two percent, even as risk appetite has sent stocks on a tear. At least for now, investors still see U.S. debt as the safest of safe havens.

"In terms of Finance 101, technically it is risk free," Blanchard said. With inflation relatively low, "The U.S. government gets an interest rate free loan…and won't be allowed to default" because the Fed can print money despite inflationary risks, he said.