Tax Cut Compromise May Spur Bond Vigilantes Into Action

Obama-GOP Tax Cut Compromise May Incite Bond Vigilantes
Obama-GOP Tax Cut Compromise May Incite Bond Vigilantes

Nouriel Roubini, the New York University economics professor who has earned the nickname "Dr. Doom" for his gloomy and often accurate predictions, says he's concerned that the tax cut compromise struck by President Barack Obama and Republican leaders in Congress could expose the U.S. to bond vigilantes who will drive up bond yields, resulting in higher borrowing costs for the federal government, CNBC reported.

After telling The New York Time's DealBook on Monday that the country's real estate problems are "underappreciated" and banks could face another $1 trillion in housing-related losses, Roubini turned his attention to the tax cut agreement. He said on Twitter: "Obama-GOP tax deal costs $900 billion over two years. US kicking the can further down the road. Are bond vigilantes starting to wake up?"

Roubini Has Company

The term "bond vigilantes," coined by economist Ed Yardeni in 1984, refers to investors who protest monetary or fiscal policies by selling bonds, thus increasing yields (bond prices and yields move in the opposite direction). If the bond vigilantes fear that a nation's policies will increase inflation or -- in this case -- expand its deficit, they would demand higher yield on bonds as the country's economic risk increases (see Greece, Ireland, etc.).

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Roubini isn't the only one who's worried. Dave Kansas of The Wall Street Journal's MarketBeat warned that the return of bond vigilantes could put a severe dent in the Federal Resesrve's expansive monetary policy, which aims to lower yields.

And Li Daokui, an adviser to China's Central Bank, said on Wednesday that the fiscal health of the U.S. is worse than Europe's, Reuters reported, and he predicted that U.S. bond prices and the dollar would fall when the European situation stabilizes.

Treasury bonds, which already sold off this week, are dropping in early Wednesday trading, sending their yields higher. The yield on the 10-year Treasury note rose to 3.23%, its highest level since June.