Trump "surrendered," and there is a significant contribution from the "U.S. debt vigilantes"?

Under the immense pressure of U.S. Treasury yields soaring to 5%, U.S. Treasury investors successfully "forced" the suspension of Trump's tariff policy, once again demonstrating the powerful influence of "bond vigilantes."

After the large-scale import tariff policy announced by Trump took effect on April 9, the U.S. Treasury market collapsed instantly. Many bond investors were concerned that the tariffs would exacerbate inflation and reduce foreign demand for U.S. assets, leading to a massive sell-off of U.S. Treasuries to pressure the government into changing its policy.

This tactic worked: just 13 hours after the tariffs took effect, Trump announced a suspension of the increases. He first softened his stance on the tariff policy, admitting, "The bond market is very tricky; I've been watching it closely"; then he changed his comments regarding Powell. Subsequently, yields quickly fell back to around 4.8%.

Previously, Trump remained unyielding in the face of a stock market sell-off and a $6 trillion evaporation in market value, ignoring domestic and foreign opposition. However, faced with the strong reaction from the bond market, warnings from business leaders, and frequent signals from economic data, Trump had to "back down" twice.

"Bond Vigilantes": The Invisible Overseers of Government Finance

Senior economist Ed Yardeni referred to this turnaround as another victory for the "bond vigilantes." These investors exert pressure on the government by selling bonds, forcing it to change what is perceived as reckless economic management policies.

Yardeni wrote after Trump announced the suspension of tariffs:

"The bond vigilantes are back in action. In terms of the U.S. financial markets, they are the only historical winners."

When government spending far exceeds revenue or adopts policies that may stimulate inflation, the value of bonds tends to decline. The government typically finances spending by issuing bonds, and an increase in bond supply leads to a decrease in the value of existing bonds. At the same time, rising inflation means that the future value of interest earned by bond investors will decrease.

To force the government to change its policies and control excessive bond supply or inflation, bond investors collectively sell bonds. As bond prices fall, yields rise to a level that the government cannot bear, necessitating a change in policy direction.

Historical Victories of the "Bond Vigilantes"

The most famous victory of the "bond vigilantes" in the 1990s was forcing President Bill Clinton to scale back his ambitious domestic agenda. According to journalist Bob Woodward's book "The Agenda," Clinton once angrily told his aides:

"Are you saying the success of the economic plan and my re-election depend on the Federal Reserve and a bunch of damn bond traders?" Clinton's political advisor James Carville stated in 1993:

"I used to think if there was reincarnation, I would want to be the president, the pope, or a baseball player with a .400 batting average. But now I want to be the bond market. You can scare everyone."

In the following decades, the "bond vigilantes" have largely been dormant. Even after the 2008 financial crisis, the Federal Reserve maintained interest rates near zero by purchasing trillions of dollars in government bonds, suppressing the influence of the "bond vigilantes."

Is the U.S. Facing a Debt Crisis?

Current Vice President JD Vance expressed during his campaign concerns that a second Trump administration might face a "death spiral in the bond market," where higher debt levels increase borrowing costs, slow economic growth, and make it harder for the government to repay its debts, ultimately leading to an economic crisis.

U.S. debt is nearing the size of the economy, double that of the Clinton era. In the fiscal year 2024, the U.S. deficit is equivalent to 6.4% of GDP, a level typically seen only during economic recessions. The interest payments on just $28 trillion in debt exceed U.S. defense spending.

Bloomberg quoted hedge fund Bridgewater founder Ray Dalio's view that if the budget deficit is not significantly reduced, a crisis in which the U.S. government cannot finance its debt is "likely" to occur in the coming years.

A model developed by the New York Fed shows that the term premium on 10-year Treasury bonds rose to about 0.7% in April, the highest level since 2014, indicating growing investor concerns about the sustainability of U.S. long-term fiscal policy.

Treasury Secretary Scott Bessent has sought to reassure the "bond vigilantes," stating that he will urge Trump to reduce the deficit to 3% of GDP by the end of his term. He also mentioned that solutions to reduce debt include cutting government spending, increasing energy supply to lower inflation, and implementing growth-promoting tax cuts and deregulation. However, investors are skeptical about the extent of spending cuts and deficit reduction.

Yardeni pointed out:

"The good news is that the deficit is a political issue that can be resolved. It just requires political will. Sometimes you need to scare politicians, and the bond vigilantes are in a position to do that."