Incoming President Donald Trump Has the Stock Market Rolling -- but the Bond Vigilantes Are on High Alert

GOP presidential candidate Donald Trump's victory in the U.S. presidential election gave the stock market a shot of adrenaline and sent everything from Bitcoin to bank stocks to small-caps soaring. The Dow Jones Industrial Average surged more than 1,500 points, its best post-election day in more than 125 years.

Investors are bullish on more Trump tax cuts and a pro-growth agenda they believe could send the market to new highs. While this could certainly happen, Trump's policy agenda is more complicated than just tax cuts. The bond vigilantes will likely be lurking.

Here's why.

The national debt is growing and Trump isn't expected to help

The U.S. national debt seems to grow every year and is now nearing $35.5 trillion. Both Democrats and Republicans are to blame for the federal deficit, which is when the government spends more than it makes in revenue during the fiscal year. The deficit grew 8% under President Joe Biden to $1.8 trillion in fiscal year 2024, the third highest on record.

The situation gets more untenable each year. Debt-to-gross domestic product is at 124% and the government this year has spent 13% of its budget on making interest payments on the national debt. That's $882 billion -- more than the U.S. spent in other budget categories this year, such as Medicare and defense.

Over the years, many have wondered if the debt truly matters. That's because the U.S. is the reserve currency for the world, so a serious default on the debt would be detrimental to the entire global economy -- and therefore investors are likely to go out of their way to avoid such a scenario. However, the University of Pennsylvania Wharton School's budget model estimated in 2023 that a 200% debt-to-GDP ratio is likely unsustainable and would trigger a default that would "reverberate" throughout the U.S. and global economy. Wharton estimates that the U.S. has about 20 years to try to correct the situation.

Why the bond vigilantes are concerned about Trump

If they had won, both Democratic candidate Vice President Kamala Harris and Trump were expected to implement inflationary policies that would add to the nation's debt load. However, the base estimate expected Harris to add another $3.95 trillion to the debt during her term and for Trump to add another $7.75 trillion during his term in office. Not exactly high marks for either candidate but clearly worse under Trump.

Market Strategist Ed Yardeni coined the term "bond vigilantes" in the 1980s to describe investors who sold bonds (or threatened to sell) when they lacked faith in the issuer -- in this case, the U.S. government due to its fiscal policy or overall finances. Bond prices and bond yields have an inverse relationship. Selling bonds lowers bond prices and pushes up yields.

While stocks were blasting into orbit on Nov. 6, bond yields surged as well. The yield on the 10-year U.S. Treasury bond jumped almost 25 basis points, reaching 4.48%, the highest since July when the broader interest rate outlook was more uncertain. Bond yields are also influenced by other factors such as economic growth, so it's possible yields rose on a more positive note.

But Yardeni, according to Bloomberg, said the bond vigilantes certainly contributed to the ascent. "The fact that Trump won with so much support gives him a tremendous amount of power not only here but on a global basis," he said. "The bond market is rightly concerned about fiscal policy continuing to be stimulative with deficits already very wide."

There is a near-term concern

While debt issues have been around for most of the 21st century, investors are growing increasingly concerned. Billionaire hedge fund managers like Stanley Druckenmiller and Paul Tudor Jones have said publicly that they expect rising inflation and are buying gold, Bitcoin, and other risk-on stocks as a hedge.

A total implosion might be two decades away, which is still too close for comfort, in my opinion. However, the bond vigilantes could be a problem for the bull market in the near term. Although the Federal Reserve is in the process of lowering interest rates, bondholders can push up yields on Treasuries like the 10-year if they believe there is added risk in lending the government money. It could be tough for the market to sustain these high levels and the bull market if longer-term bond yields accelerate higher.

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Bram Berkowitz has positions in Bitcoin. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.