Beneath the seemingly calm surface of the bond market over the past few months, a test of wills has been unfolding between the U.S. government and investors concerned about America's long-term high deficit and high debt levels.
Since President Trump's announcement of large-scale tariff increases on trading partners on the so-called 'Liberation Day' in early April triggered turmoil in the U.S. bond market, the Trump administration has been carefully adjusting its policies and public statements to prevent further market disruptions. However, some investors have noted that this 'truce' remains highly fragile.
This fragility resurfaced on November 5, when the U.S. Treasury hinted at considering an increase in the issuance of long-term government bonds. On the same day, the U.S. Supreme Court began deliberations on the legality of Trump's sweeping trade tariffs. The benchmark 10-year Treasury yield — which had already declined significantly this year — surged more than 6 basis points, marking one of the largest single-day increases in recent months.
Against the backdrop of growing unease in the market over the scale of the federal fiscal deficit, the Treasury’s proposal raised concerns among some investors about upward pressure on long-term Treasury yields. Meanwhile, the Supreme Court case cast doubt on a key revenue source — tariffs — used to service the $30 trillion of government debt held by the market. In a daily report on November 6, Citigroup analyst Edward Acton referred to this juncture as 'a reality check.'
A survey of over a dozen senior executives from banks and asset management firms revealed that respondents believe a test of wills is indeed underway beneath the apparent calm of the bond market over the past few months, pitting the U.S. government against investors worried about long-term high deficits and debt levels. Reflecting these concerns, the so-called 'term premium' — the additional yield investors demand for holding 10-year Treasuries — has begun to rise again in recent weeks.
Daniel McCormack, head of research at Macquarie Asset Management, stated: 'The bond market’s ability to intimidate governments and politicians is unparalleled, and you’ve already seen this happen in the U.S. earlier this year.' He was referring to the April bond market rout, which forced the government to soften its plans for higher tariffs. He added that unresolved public finance pressures could lead to political issues over the long term, as voters grow 'increasingly disillusioned' with government performance.
U.S. Treasury Secretary Bessent has repeatedly emphasized that his focus is on keeping yields low, particularly those of the benchmark 10-year Treasury, as they influence everything from federal government deficits to borrowing costs for households and businesses. In a speech on November 12, Bessent remarked: 'As Treasury Secretary, my job is to be the nation’s top bond salesman, and Treasury yields are a critical metric for measuring how well I’m doing.' He also pointed out that borrowing costs across the entire yield curve have declined.
These public statements, along with private engagements with investors, have led many in the market to believe that the Trump administration is genuinely serious about managing Treasury yields. Data shows that following the Treasury’s proposal to expand an ongoing repurchase program aimed at improving market operations, some investors unwound positions in the summer that had previously bet on falling bond prices.
The Treasury has also discreetly sought investor opinions on major decisions, with an insider describing this approach as 'proactive.' According to the source, in recent weeks, the Treasury consulted bond investors on the potential market reaction to five candidates under consideration for Federal Reserve Chair. Investors were informed that a nomination of Kevin Hassett, director of the National Economic Council, might elicit a negative market response due to perceptions of his close ties with Trump.
Under the Watchful Eyes of Bond Vigilantes
Several investors indicated that they believe these measures by the Trump administration have merely bought some time. Amid the need for the U.S. to finance an annual deficit accounting for approximately 6% of GDP, the "peace" in the bond market remains at risk. Market participants noted that the government has barely managed to suppress the "bond vigilantes"—investors who punish fiscal recklessness by driving up yields—but only just.
Investors stated that price pressures from tariffs, the bursting of an artificial intelligence (AI)-driven market bubble, and the prospect of an overly accommodative Federal Reserve potentially fueling inflation could all disrupt the current equilibrium. Sinead Colton Grant, Chief Investment Officer of Bank of New York Mellon Wealth Management, remarked, "Bond vigilantes never disappear; they are always present. The key is whether they are active or not."
White House spokesperson Kush Desai stated that the U.S. government is committed to ensuring the robustness and health of financial markets. He remarked, "Reducing waste, fraud, and abuse in runaway government spending, along with curbing inflation, are among the many actions taken by this administration. These efforts have bolstered market confidence in the U.S. government's fiscal position and lowered the 10-year Treasury yield by nearly 40 basis points over the past year."
The bond market has historically punished fiscally irresponsible governments, sometimes even costing politicians their positions. As Trump began his second term, several indicators closely monitored by bond traders had already flashed red—the total U.S. government debt exceeded 120% of annual economic output.
On April 2, following Trump's imposition of high tariffs on dozens of countries, concerns among bond traders escalated rapidly. Due to the inverse relationship between bond prices and yields, bond yields experienced their largest weekly increase since 2001, with the dollar and U.S. equities also falling simultaneously. Subsequently, Trump backed down, postponing the implementation of tariffs, and the final rates imposed were lower than initially proposed. As yields retreated from what he described as a "disgusting" moment, he praised the bond market as "beautiful." Since then, the 10-year U.S. Treasury yield has declined by more than 30 basis points, and a measure of bond market volatility recently dropped to its lowest level in four years.
Signaling to the bond market
On the surface, it appears that bond vigilantes have gone quiet. Investors suggested that one reason for this calm is the resilience of the U.S. economy. Massive investments driven by AI offset the drag on growth caused by tariffs, while a slowdown in the labor market prompted the Fed to enter a rate-cutting mode. Another factor is that the Trump administration undertook a series of measures to signal to the market that it does not wish to see uncontrolled rises in U.S. Treasury yields.
On July 30, the U.S. Treasury Department announced it would expand a repurchase program aimed at reducing the amount of long-term, less liquid debt in circulation. While the initiative was intended to enhance the ease of bond trading, some market participants suspected it was an attempt to suppress yields on 10-, 20-, and 30-year Treasuries, given the focus of the expanded repurchases on those maturities.
The U.S. Treasury Borrowing Advisory Committee—a group of traders providing debt-related recommendations to the Treasury—indicated that there was "some debate" among its members regarding whether this approach might be "misinterpreted" as shortening the average maturity of U.S. Treasuries. The aforementioned sources noted that some investors worry the Treasury might adopt unconventional measures, such as aggressive repurchase programs or reductions in long-term Treasury issuance, to limit upward pressure on yields.
Data shows that during these discussions over the summer, short positions in long-term U.S. Treasuries declined. In August, short positions in Treasuries with remaining maturities of at least 25 years decreased significantly but have begun to rise again in recent weeks.
Jimmy Chang, Chief Investment Officer of Rockefeller Global Family Office, which manages $193 billion in assets and is part of Rockefeller Capital Management, stated: 'We are in an era of financial repression, where governments use various tools to artificially suppress bond yields.' He referred to this as a 'disturbing equilibrium.'
The U.S. Treasury Department has also taken other measures to support the market, such as relying more on short-term Treasury bills (T-bills) to finance deficits rather than increasing the supply of long-term government bonds. It has also called on banking regulators to relax rules to make it easier for banks to purchase U.S. Treasuries. Analysts at JPMorgan estimate that even if the U.S. budget deficit for fiscal year 2026 is expected to be roughly the same as for fiscal year 2025, the supply of U.S. government debt with maturities exceeding one year issued to the private sector next year will still decline.
Demand for Treasury bills is also expected to receive a boost. The Federal Reserve has ended its balance sheet reduction, meaning it will once again become an active buyer in the bond market, particularly for short-term debt. Additionally, the Trump administration's embrace of cryptocurrencies has created a new and significant buyer of government bonds—stablecoin issuers. Bessent noted in November that the current stablecoin market, valued at approximately $300 billion, could grow tenfold by the end of this decade, thereby significantly increasing demand for Treasury bills.
Ayako Yoshioka, Director of Portfolio Advisory at Wealth Enhancement Group, stated: 'I feel there is less uncertainty in the bond market; supply and demand are simply becoming more balanced. It’s a bit strange, but so far, it has worked.'
How long can this fragile balance last?
However, many market participants are concerned about how long this situation can persist. Meghan Swiber, Senior U.S. Rates Strategist at Bank of America, stated that the current stability in the bond market relies on a 'fragile equilibrium'—on one hand, moderate inflation expectations, and on the other, the Treasury’s increased reliance on short-term debt issuance, which has suppressed concerns about supply. She pointed out that if inflation surges and the Federal Reserve shifts to a hawkish stance, U.S. Treasuries may lose their appeal as a risk-diversification tool, and demand concerns could resurface. Relying on Treasury bills to finance budget deficits also carries risks, and some sources of demand, including stablecoins, are inherently volatile.
Milan, currently the Chairman of the White House Council of Economic Advisers and also a member of the Federal Reserve Board, criticized the Biden administration last year for adopting an approach similar to what Bessent advocates now—relying on Treasury bills to finance deficits. Milan believed at the time that this meant the government was accumulating short-term debt, which might require refinancing at higher costs if interest rates suddenly surged. However, Milan now declines to comment further on his views from last year, only noting that he predicted in a September speech that national borrowing levels would decline.
Stephen Douglass, Chief Economist at NISA Investment Advisors, stated that the currency depreciation and yield spike that occurred after Trump announced tariffs in April are phenomena typically seen only in emerging markets, a situation that has made the government uneasy. 'This has become an important constraint.'
Editor/Doris