Have the Bond Vigilantes Finally Arrived?

It sure looks like it.

Bonds were routed badly today as the bond market continues to sell QE2.

The trends are pretty frightening.  Here is the 10 year bond going back to last week when QE got started:

Here is the 30 year:

The market took notice as the bond sell off accelerated late in the day, and gave up all of the gains made during the trading session:

My Take:

It's pretty clear that the bond market has had enough of the Fed's antics.  The ten year yield moved up 1.5 points today!  That's about as violent as it can get. 10 year yields are now approaching 3% after sitting at 2.4% just a few weeks ago.

Since mortgage rates are basically based off the ten year bond, you can assume that rates will be up about a half a point.  This is a blow that the crippled housing market cannot afford to take right now.

Ben Bernanke told us that QE was being done to ensure that rates stayed low. 

The market has responded by moving in the exact opposite direction. 

Essentially, the Fed's QE policy has been completely rejected by the markets. 

Folks, if the Fed loses control of the bond markets things are going to get real ugly very rapidly.

The inflationary effect that QE has had on commodities despite the recent pullback in commodities is another headwind that faces bonds. 

The increased inflation is forcing bond investors to demand higher yields because they are afraid that the QE inspired inflation will wipe out their gains. 

As I have said before, if you own a bond that yields 3% and prices rise 6% annually due to inflation your bond investment is losing 3% in real value each year.

Something else that is really concerning is the sell off in the muni markets(especially California).  Take a look at Pimco's Cali bond fund:

Something is going on folks and it isn't pretty.  People are running away from fixed income in droves.  This smells really bad.

If bond vigilantes are back and decide to pull a "Greece" and take interest rates rise to near double digits you can be sure that things will never be the same here in the good ole USA.

The speed in which this is all going down is flat out frightening.  The violence of the sell off has me thinking that the vigilantes are indeed back.  If this is really true then hold onto your seats!

I say this because the vigilantes are usually ruthless when they have seen enough when it comes to spending.  They have a tendency to relentlessly take rates higher until the spending stops.  The Fed in response will have no choice relent and slash spending because the bond market dwarfs them in terms od size.

If this is what is going down then you can expect to see another financial collapse because the government will no longer be able to paper over the losses via government spending.

The Bottom Line

We could be reaching a tipping point in a matter of days or weeks.  If you are long stocks via the "easy money Fed trade" then I think you might want to reconsider.

We will see a deflationary collapse if rates continue to rise like this because the fraud and the losses that accompany it will be exposed.  It's too early to call this of course but the trend has definitely been set.  It remains to be seen as to whether or not it continues.

If we start getting close to 4% on the 10 year we are in DEEP trouble because we have so much debt that we need to service.

One thing is clear trend or no trend:  Since QE started, some extremely large investors are bailing out of our credit and muni markets.Someone doesn't like what they see which is unsettling to say the least. 

Ben and the Fed now have a decision to make:  Do they continue QE and get into a potential brawl with the bond vigilantes or does he possibly end the program in the hopes that the bond market will settle down and keep rates low.

Has judgement day arrived?  I'm afraid will know soon enough.