Trump's economic agenda faces a big potential foe: The bond vigilantes
From sweeping tariffs to big tax cuts, President-elect Donald Trump has an ambitious economic agenda. One group, however, could stand in his way: the bond vigilantes.
Bond prices have dropped sharply since Trump's election as investors worry that his economic policies will reignite inflation and lead to surging fiscal deficits. And that matters.
The U.S. bond market is the biggest in the world, and all kinds of interest rates are tied to how the market performs. When bonds drop, it can hurt the U.S. by making it much more expensive for the government to borrow money. And it affects regular Americans, too, by jacking up the cost of loans, from mortgages to car payments. A lot of people also hold bonds in their investment or retirement portfolios so they could face potential losses.
So when bond prices are in freefall or drop for a prolonged time, all kinds of alarm bells go off — and the sell-off can quickly spread. The turmoil can become powerful enough to bring down governments.
That gives bond investors big influence — and they can use to it to try to hold governments accountable and force them to reverse their economic policies. The market even has a term for investors who exert pressure in this manner: bond vigilantes.
Here's how bond markets work — and why you'll need to pay attention to bond vigilantes as Trump gears up for a new term.
Understanding bonds
Bonds are essentially like loans. The government needs to borrow money to function and to afford all of its spending. So it sells bonds to a wide range investors, from banks to other countries to individual people.
Uncle Sam promises to pay these investors back — with interest. In market talk, the interest is called the bond yield.
Changes in bond prices affect the interest due on that bond. It's a simple rule: Bond prices and yields move opposite from each other. When bond prices rise, their yields fall, meaning investors are happy to accept lower interest payments.
But when bond prices fall, their yields rise, since investors demand more interest as compensation.
A surge in yields can be a big problem
The U.S bond market is an integral part of the country's financial system because banks and other institutions use bond yields — especially the one for the 10-year government debt — as a benchmark to help them price all kinds of loans, from mortgages to the interest rates on credit cards or car loans.
So when bond prices are falling and yields are rising, it can make borrowing more expensive. The recent rise in bond yields, for example, has helped push the 30-year mortgage rate up sharply to 6.78% from just above 6% in late September.
This affects not just average people but the U.S. government, too. Every year the U.S. sells trillions of dollars in bonds to investors to be able to afford its spending. And when bond yields surge, investors will demand more interest, making it much more expensive for the government to borrow money.
Those rising interest payments can make the country's deficits even worse. In the last fiscal year, which ended Sept. 30, the budget deficit hit $1.8 trillion — the third highest in U.S. history.
Right now, yields are surging
Stocks and cryptocurrencies have risen because those investors see a lot to like in Trump's promise to boost economic growth. His promise to lower taxes, for example, could help boost corporate profits and spur more investments.
But bond investors have reacted with alarm. The 10-year government bond, for example, has dropped since the election, sending its yield sharply higher.
Debt investors have two main concerns. First, Trump's promises to keep a broad set of tax cuts passed in 2017 during his first administration and to introduce new ones — like exempting taxes on tipped income — could lead to even bigger fiscal deficits. The nonpartisan Committee for a Responsible Budget has estimated that Trump's plans could increase the national debt by $7.75 trillion over the next decade or so.
Bond investors are also alarmed at another big Trump promise: sweeping tariffs. The U.S. imports far more than it exports, and many economists warn tariffs could raise the price of everything from tech gadgets to shoes as companies pass on those costs to consumers.
Rising yields couldn't come at a worse time
Higher prices for goods could exacerbate inflation at just about the worst time.
The Federal Reserve has spent months wrestling inflation rates down. Consumer prices rose 2.6% in October from a year ago — down substantially from the decades-high peak of 9.1% in June 2022.
Lower inflation allowed the Fed to start cutting interest rates in September. But policymakers will need to pause or reduce those rate cuts if Trump reignites inflation by implementing the policies he's promised.
The Fed is also likely to be concerned if the country experiences surging debt levels. In a speech at Spelman College in December 2023, for example, Fed Chair Jerome Powell said "the federal budget is on an unsustainable path."
Trump could face one issue: Bond vigilantes could strike
When bond investors get spooked they can become vigilantes — and they can extract a cost on leaders and governments around the world.
Take what happened in the U.K. in 2022.
When the administration of then-Prime Minister Liz Truss unveiled a budget that would sharply cut taxes without a clear plan for how to pay for them, bond vigilantes revolted.
They sold off U.K. government bonds, while the pound sank, leading to market turmoil and negative headlines. Truss had to backtrack a few weeks later by reversing the tax cuts and firing her finance minister. Truss resigned soon after, infamously having been outlasted by a lettuce.
The idea that bond vigilantes could take down a Trump administration is far-fetched, given that the U.S. bond market is magnitudes bigger than the U.K.'s. But bond investors can still extract a heavy toll. Should they sell off or cut their purchases of debt, it could create market turmoil in other parts of Wall Street, like stock markets, and spark a financial storm.
That could make it harder for Trump to accomplish his goals. He'd have to force his government to defend his economic policies — and justify whether they are worth potential damage to the country's finances.
