Tax Bill: More Market Chaos in Store If Bond Vigilantes Send Yields Higher

Tariff chaos may have subsided, but markets could be in for another bout of policy-fueled volatility in the coming months if bond investors throw a tantrum over the tax bill.

President Donald Trump’s “Big, Beautiful Bill”—the 389-page tax bill that aims to extend Trump’s 2017 tax cuts—could add around $4 trillion to the US deficit over the next decade, according to a projection from the Tax Foundation, a non-partisan think tank.

While the bill stalled on Friday amid opposition from within the Republican party, it is likely that a tax bill will get done this year.

For bond investors worried about the sustainability of government spending and the safe-haven status of US Treasurys, any fiscal moves that add to the deficit are bad news.

So far, the bond market has been quiet. Yields are down this week as rate cut bets get repriced amid cooler inflation data.

But that could change quickly as the tax bill gets closer to becoming law.

Ed Yardeni, the president of Yardeni Research, predicted the yield on the 10-year US Treasury could spike as high as 5% as details of the tax bill get ironed out. A 5% yield is a key psychological threshold for the market and has sparked big sell-offs in stocks in recent years when that level has been reached.

“I think they’re watching with great interest how that’s unfolding,” Yardeni said of the bond market, speculating another Liberation Day-type sell-off could occur in government bonds if Republicans try to push the tax bill forward in its current form.

Padhraic Garvey, the regional head of research for the Americas at ING, also said he saw yields edging back toward 5% as the tax bill gets closer to becoming law. He also pointed out that the US debt ceiling is set to increase around that time, which could fan more panic over government borrowing.

“That’ll be an interesting period where the bond market has got to decide, ‘Well, do we like the smell of this?'” Garvey told BI, speculating that an “unnerving” sell-off in bonds was possible.

“The Treasury market won’t like it,” he added of the current tax plan.

Peter Berezin, the chief global strategist at BCA Research, estimated there’s a 30% chance the bond market could see a “nightmare scenario,” where the new tax bill prompts fears of fiscal crisis and sends the 10-year US yield soaring past 6%.

In that situation, demand for US government debt securities would be so weak that the Fed would need to step up and buy Treasurys to help keep the government funded.

“I will say that the risk of such an outcome is uncomfortably high,” Berezin told BI, though he acknowledged that it wasn’t his base case.

“Unless Trump is willing to cut these entitlement programs for defense spending or raise taxes, none of which I think he’d be willing to do easily. We could see this crisis play out in a fairly significant way where yields go up quite a bit before the Fed can step in,” Berezin said.

Are the bond vigilantes really out there?

The bond market got a lot of credit for staying Trump’s hand during April’s market meltdown over tariffs.

Trump later denied the sharp rise in yields was behind his decision to pause most tariffs for 90 days on April 9, but he had admitted to at least watching the bond market as it reacted violently to the trade war.

So, who are the bond vigilantes, and do these investors really have power over the president?

To be clear, the $29 trillion market for US Treasurys is the largest in the world, and no one investor or even group of investors could easily move it.

According to Yardeni, who is often credited with coining the term, bond vigilantes refers to the bond market itself, rather than specific investors who make it their mission to protest policies by selling bonds and spiking yields.

Bond vigilantism is more of a description of the market’s reaction to policies that could make Treasurys less safe, according to Yardeni.

Right now, bond investors are concerned about two big macro forces:

1. US debt. High levels of government borrowing raises doubts that the US will be able to meet its debt obligations, causing demand for US Treasurys to fall. Anything that worsens the outlook for the US deficit—like tax cuts—is on the radar of investors.
2. Inflation. Higher inflation generally means higher interest rates in the economy. That means US debt is more expensive to service and also casts doubt on whether the US will be able to meet its debt responsibilities. In 2024, the government spent $881 billion on interest payments, according to the Congressional Budget Office.

Trump has said that a goal is to lower interest rates for Americans during his term, and he’s keeping close watch on the 10-year Treasury yield as a scorecard.

Bond yields have been on a roller coaster this year already, climbing when he first unveiled tariffs on Mexico and Canada, and then rocketing higher after his “Liberation Day” announcement.

Yardeni says he believes it’s likely Trump will blink on some items in his tax bill to avoid another confrontation with bond market vigilantes. The president wants lower rates and needs bond auctions to go smoothly, as spotty demand for US Treasurys could easily spike rates to levels that could cause a recession, he said.

“I think the administration will do what’s possible politically to placate the bond vigilantes, but it won’t be a guessing game. The news will come out about how this thing’s progressing and what actually gets implemented, and the bond market will get to decide whether the right choices were made or not,” Yardeni said.

“The package that I see potentially getting passed is an attempt to make it not as dramatic as it could be,” Garvey told BI on potential policy walk-backs.