(Bloomberg) -- Donald Trump’s sweeping win in the US presidential election set off a torrent of buy signals across Wall Street. There was, however, one notable exception.
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As traders sent assets from stocks to the dollar rocketing on optimism that a second Trump administration would be good for business and stoke an already strong economy, investors in the $28 trillion market for US government debt drove yields to the highest in months.
The selloff is a reminder from a powerful constituency: The so-called bond vigilantes are monitoring the self-described “King of Debt” as he claims an “unprecedented” mandate to carry out an agenda of tax cuts and tariffs.
By lifting interest rates, financial markets are indicating they will impose a penalty on policies they regard as likely to ignite inflation and swell the national debt. Higher borrowing costs could in turn filter into Trump’s economy, slowing growth and other markets.
“It’s a new day in America and a new day in the bond market,” said Ed Yardeni, the veteran strategist who coined the term “bond vigilantes” in the early 1980s to describe investors who sought to exert power over government policies by selling their bonds, or merely threatening to do so.
“The fact that Trump won with so much support gives him a tremendous amount of power not only here but on a global basis.” he said. “The bond market is rightly concerned about fiscal policy continuing to be stimulative with deficits already very wide.”
The 10-year Treasury yield, the risk-free benchmark that anchors more than $50 trillion in global dollar-denominated fixed-income securities, soared by almost a quarter point Wednesday to reach 4.48% at one point, the highest since July.
Yardeni is among investors who see it possibly touching 5% again, should Trump’s fiscal policies raise investors’ ire.
The US isn’t the only place where bond vigilantes are reappearing. They recently sought to impose discipline on the fiscal programs of France and the UK too. Meanwhile, in Germany, bonds tumbled Thursday on speculation about further debt sales after the government there crumbled.
The original bond vigilantes of the 1980s arose amid a period when the US had experienced a prolonged bout of unusually high inflation. Since then, they have turned up from time to time, including during former President Bill Clinton’s first term, when he tried to push through an ambitious domestic agenda.
Fast-forward to today and even without factoring in the effects of a change in leadership, the nonpartisan Congressional Budget Office in June projected that chronic deficits will lift the debt to about $48 trillion by the end of 2034. Already, net interest payments cost are equivalent to 3.06% as a share of gross domestic product, the highest ratio since 1996.
The Committee for a Responsible Budget last month estimated Trump’s plans would increase the debt by $7.75 trillion to the current projected debt levels through fiscal year 2035 as a result of his deficit-increasing initiatives.
While the CFRB noted that the sum could range from as low as $1.65 trillion to as high as $15.55 trillion, the increasing probability of a Republican sweep of Congress — the Senate has already flipped red and the House is in play — raises the odds that Trump’s plans won’t be held back by politicians.
“Fiscal policy is more important to us as investors today, because of the size of the deficit and the magnitude of the US debt,” Mark Dowding, chief investment officer at RBC BlueBay Asset Management.
What Bloomberg’s Strategists are Saying...
“It will be interesting to see just how far Trump and a compliant Congress are willing to push things. In the near term, the Fed is unlikely to weigh in until some specific policy proposals are mooted and/or passed.”
— Cameron Crise, MLIV macro strategist
Bond yields and inflation expectations were already on the rise before Tuesday’s vote. The 10-year breakeven rate, a market gauge of where long-term inflation is heading, surged to as high as 2.43%, its highest level since April.
It had been moving up since September as the economy proved resilient after the Federal Reserve cut rates a half point that month, and the prospects of a Trump win grew in the betting markets.
With Trump’s platform seen as inflationary, some economists already see the Fed reducing rates less than previously forecast after it cuts by a quarter point on Thursday. That too would likely pressure bond markets.
There is also evidence that investors are demanding higher yields in exchange for taking on the risk of holding longer-term debt.
The so-called term premium — a component of yields that compensates investors for buying long-maturity debt rather than rolling short-term securities, and is seen as protection against unforeseen risks such as inflation and debt supply-demand shocks — has been climbing. A New York Fed model of 10-year term premium jumped to about 22 basis points as of Nov. 4 from negative 29 basis points in September.
“Governments need to be mindful that investors may demand higher compensation if they are not careful with their budgets,” said Robert Dishner, senior portfolio manager at Neuberger Berman.
Trump says the key to addressing the fiscal outlook is yet more tax cuts, which he argues will boost economic growth and thus revenues, offsetting the hit to the government’s bottom line. Most economists disagree and see US debt climbing beyond 100% of gross domestic product under his leadership.
It may turn out that Trump’s plans aren’t as inflationary as some fear. He may even scale back some aspects in the face of a bond market tantrum. And any push higher in long-term yields toward 5% would likely entice some investors.
Still, as long as US debt and deficits remain elevated, they will be pressure points.
“The deficit spending is definitely not going away,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities. “That will be a consistent theme although that doesn’t mean that yields aren’t going to eventually hit a level that brings in buying interest — it’s just hard to say exactly where.”
(Updates with details from German bond selloff in ninth paragraph.)
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