What the recent tantrum in bonds says about investors' changing view of Trump

• Trump's policies may trigger inflation, affecting both stocks and bonds negatively.
• Investors worry about inflation due to Trump's proposals on tariffs, taxes, and mass deportations.
• Rising bond yields and potential deficit spending could further strain the market.

Wall Street embraced Donald Trump's election win in November, catapulting the stock market to record highs on the prospect of a business-friendly agenda and strong economic growth.

But fast-forward just a couple of months, and reality is starting to set in among investors that Trump's policy proposals of universal tariffs, lower taxes, and mass deportations could spark a rebound in inflation and set off a market scenario reminiscent of 2022, when stock and bond prices fell in tandem.

The recent surge in bond yields, with the 10-year US Treasury yield edging closer to the psychologically important 5% level, has telegraphed the potential for such an outcome. The last time that happened, stocks saw a brutal sell-off and the plunge in bond prices marked one of the worst crashes in market history.

The 10-year US Treasury yield touched 4.70% on Wednesday, representing its highest level since late April, and is up about 50 basis points since Trump's election win on November 6.

The bond market's message is clear: Trump's proposed policies may not simply be a driver of growth, but could exacerbate inflation and make markets trickier to navigate.

Where rising bond yields often coincide with a solid economy, the recent surge seems to be squarely focused on the threat of a rebound in inflation and the potential for the central bank to have to keep rates high in order to counteract government policies.

"The Bond Vigilantes aren't buying the Fed's esoteric narrative that the federal funds rate (FFR) needs to be cut," Ed Yardeni said in a recent note.

"What matters more to them is that inflation in the core services components of the CPI and the PCED remains sticky well above 2.0%. Long-term yields may continue rising until the Fed acknowledges the economy's strength and officially hits the FFR pause button," he added.

Yields are nearing a threshold that's sparking concern that even if the economy continues to grow at its current brisk pace or even accelerates, it would come at the cost of surging inflation.

That would put pressure on the stock market, reviving memories of other inflationary episodes in American history, such as the 1970s and early 1980s.

"We believe the rate pressure could become a bigger headwind to equities than the tailwind from a good economy," Bank of America said in a recent note.

President-elect Trump's request that Congress pass "one beautiful, big" spending bill instead of piecemealing it and passing multiple bills over time is also not helping brighten investors' mood.

If Congress follows Trump's request, it could lead to a big headline deficit spending number that could shock markets, result in ever larger US Treasury auctions, and ultimately push interest rates and bond yields higher.

"We already have discussions literally every day when we have a Treasury auction around, 'hey what was the metrics on the auctions and what are these numbers telling us in terms of the overall fiscal sustainability,' which Jay Powell of course always keeps on pointing out is already unsustainable," Torsten Slok, economist at Apollo, told Bloomberg this week.

Even if the Trump administration succeeds in reigning in the federal government's spending deficit despite proposing policies that economists argue would do the opposite, that might also spell bad news for the economy and broader stock market.

James Van Geelen, founder of Citrini Research, laid out the current market dynamics in a post earlier this week. It all hinges on the markets communicating to the Trump administration to back off on some of its proposed policies investors view as detrimental.

"Essentially, once the market realizes that Trump could be serious about cutting the deficit (through what I am sure will be many different proposed changes), it will become the market's responsibility to throw a fit when it is discussed. Because that's how you discourage Trump from actually pushing forward on it, you send the Dow down every time it's mentioned," Van Geelen said.