Are the Bond Vigilantes Coming for the Stock Market?

If you're not familiar with the bond vigilantes, now is an excellent time to catch up.

The phrase was coined by economist and market analyst Ed Yardeni back in the 1980s to describe bond investors who sell bonds en masse because they dislike certain monetary or fiscal policies. That sell-off drives bond prices down and yields -- which move in the opposite direction of prices -- higher.

Higher yields make government borrowing more expensive. That can force the federal government or the Federal Reserve to alter policies to appease bond investors and bring yields back down, because higher yields affect the entire economy, including the stock market.

In fact, this has happened many times in U.S. history. The bond market is famously credited with forcing fiscal restraint on the Clinton administration in the 1990s, helping to turn annual budget deficits into brief surpluses.

That sort of thing is why Clinton political advisor James Carville famously remarked that he wanted to be reincarnated not as the pope or a star baseball player, but as the bond market, because it can intimidate anyone.

Bond investors are reacting to surging inflation

Well, the bond vigilantes reemerged in recent days, selling Treasury securities and driving up yields. Earlier this week, the 30-year Treasury bond climbed to its highest level since 2007. The 10-year Treasury yield -- which sets borrowing rates for mortgages, car loans, and credit cards -- climbed to its highest level since January 2025.

It's widely believed this bond market activity is in reaction to surging inflation, which rose to 3.8% year over year in April, the highest inflation rate since May 2023, and what bond investors see as the Fed's inappropriate response to it. The Fed's interest-rate-setting committee maintained an easing bias in its April statement, indicating it is leaning toward a rate cut in the coming months, which would only drive inflation higher.

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"The Bond Vigilantes are threatening that if the Fed doesn't tighten credit conditions, they will do so to maintain law and order in the economy!" Yardeni wrote in a note on Tuesday. Yardeni now believes the bond market's reaction will force the Fed to adopt a tightening bias at its June meeting and then hike its target interest rate at its July meeting.

That wouldn't be welcomed by the stock market, which, until recently, had been expecting the Fed's next policy move to be an interest rate cut.

Not anymore, however. Futures traders are now pricing a 49% likelihood that the federal funds rate will be higher by year's end, not lower. They see an equal chance that the rate will not change at all this year, with only a 2% chance that it will be lower by the end of the year.

Rising interest rates are rarely good for the stock market, as they raise borrowing costs for consumers and businesses and can dent corporate profits. That said, if the Fed can get inflation back under control, it would likely pacify angry bond investors and bring yields back down, which is good for the economy.

Yardeni says the bull market isn't yet at risk of being derailed by the sell-off in the bond market, and that means now is a good time to buy both stocks and bonds. I think he's probably right, but I'll be watching closely for a further surge in bond yields.