Following the election victory of Donald J Trump on Wednesday, while stocks rallied as investors showed optimism for Trump’s policies favouring tax cuts, deregulation, and government spending, bond market movements emerged to be conspicuous for investors.

The 10-year Treasury yield, a key benchmark for global finance, increased by almost a quarter point on Wednesday to peak at 4.48% before closing at 4.425%, its highest level since July.

It now stands at 4.3%, but well above the 3.6% it was yielding right before the Fed cut rates on September 18, if still lower than this year’s high.

This spike, driven by investor concerns about potential government spending and inflation, has revealed underlying apprehension in the $28 trillion US government debt market.

The bond market: a signal of fiscal unease

The bond market has long been regarded as a bellwether for economic policy sentiment, with the saying, “The bond market is smarter than the stock market,” capturing its predictive power.

Ed Yardeni, the veteran investment strategist who coined “bond vigilantes” in the 1980s, noted the significance of this market shift.

He highlighted that Trump’s substantial support empowers him on a global scale but raises red flags for bond investors wary of continuous fiscal stimulus amid wide deficits.

By raising interest rates, financial markets signal that they will penalize policies deemed likely to fuel inflation and expand the national debt.

This increase in borrowing costs could, in turn, ripple through Trump’s economy, curbing growth and impacting other markets.

Yields have been climbing for weeks, reflecting expectations of a Trump win and a potential resurgence of inflation.

Yardeni is one of the investors who believe it could potentially reach 5% again if Trump’s fiscal policies provoke investor concerns.

Why are rising yields bad?

Rising bond yields can spell trouble for current debt holders due to the inverse relationship between bond prices and yields.

This dynamic has led to paper losses, impacting institutions like pension funds, hedge funds, and central banks worldwide that depend on US government debt as a safe asset.

Although new buyers might welcome the higher returns, the implications for global financial stability and borrowing costs are significant.

Trump’s proposed fiscal policies—extending the sweeping tax cuts from 2017, eliminating taxes on tips, and halting taxes on Social Security benefits—could dramatically increase federal borrowing.

The nonpartisan Committee for a Responsible Federal Budget estimates that his initiatives may elevate national debt by $7.8 trillion over the next decade, more than double the projected $3.5 trillion under Kamala Harris’s plans.

This escalating debt, coupled with potential inflation fuelled by tax cuts and government spending, poses a grim scenario for bond investors and raises questions about the government’s debt-handling capabilities.

The Fed’s future rate cuts face uncertainty with Trump’s economic plans

The Federal Reserve on Thursday responded to the economic climate with a 25 basis point rate cut during its recent monetary policy meeting, following a substantial 50 basis point reduction in September.

The yield on the 10-year Treasury settled at 4.35% from its Wednesday high of 4.44%, signalling some market recalibration.

However, analysts suggest that Trump’s economic agenda—centered on tax reductions and deregulation—could drive faster growth and inflation, complicating future rate cuts.

Tony Rodriguez, Nuveen’s head of fixed income strategy, noted that the election outcome might prompt the Fed to lower rates more gradually than previously planned.

“Expected cuts in 2025 we now think will be fewer and further apart,” he said, emphasizing the central bank’s caution against sparking an inflationary rebound.

With Trump’s policy intentions becoming clearer, Treasury yield projections have been revised.

Fed funds futures signal that investors foresee rates declining to around 3.7% by the end of next year—a higher trajectory than predicted just two months prior.

Strategists at BofA Global Research have revised their near-term target for Treasury yields to 4.25% to 4.75%, a notable shift from their previous range of 3.5% to 4.25%.

Could elevated yields impact stock markets?

The saying “When the bond market sneezes, the stock market catches a cold” reflects the relationship between yields and equities.

Higher interest rates on virtually risk-free bonds diminish the extra return investors seek from riskier assets like stocks, making shares a less attractive investment option.

Despite soaring Treasury yields, the stock market has thus far reacted positively, buoyed by the resolution of election uncertainty and prospects of economic growth.

The S&P 500 index hit record highs as investors anticipated business-friendly policies.

However, caution persists. Senior investment strategist Angelo Kourkafas from Edward Jones highlighted the potential for market pullbacks if yields continue to rise sharply.

“When 10-year Treasury yields neared 4.5% or went higher over the last year, it has triggered some pullbacks in equity markets,” he stated, underscoring the risk of rising borrowing costs affecting both businesses and consumers.

What to do with your 10-year notes now?

Higher yields have created dilemmas for investors holding older bonds with lower rates, eroding their market value.

While the temptation to sell and reinvest in higher-yielding bonds is strong, strategic patience could be more rewarding.

In a Barron’s report, JB Golden, portfolio manager at Advisors Asset Management, advises waiting until the market stabilizes.

“There could be some really nice opportunities,” he suggested, pointing to the potential benefits of buying 7-10 year bonds if yields climb to between 4.5% and 5%.

However, he remains cautious about longer-duration investments until there is greater clarity on the federal budget deficit’s trajectory.

Amid Trump’s ambitious spending plans, questions about fiscal responsibility have emerged.

Notably, economic heavyweights like John Paulson and Scott Bessent have voiced their concerns.

Both, potential contenders for positions like Treasury Secretary, have openly critiqued excessive government spending.

Analysts agree that the choice of Treasury leadership will heavily influence the administration’s economic direction and the markets’ response to fiscal policy.

Bond vigilantes may have signalled their return, a reminder that while bullish policies can ignite markets, they also come with a steep price—one the bond market is quick to point out.

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