Deficit Jitters Return as Bond Market Roars Back to Life

Tax Cuts in the Crosshairs Amid Fiscal Fears

Markets recently preoccupied with the threat of an escalating trade war have seen those concerns ease somewhat. However, a new source of anxiety has emerged: the growing shadow of the US fiscal deficit. Investor unease deepened last Friday when Moody’s downgraded US sovereign debt from Aaa to Aa1.

At the heart of the latest concern is the Trump administration’s push for a fresh package of tax cuts aimed at boosting the US economy. The tax bill recently cleared a key hurdle after receiving approval from a gatekeeping committee, setting the stage for a floor vote. Yet, many fear that further tax cuts could worsen the already high budget deficit

Bond Vigilantes Stir, Sending Shockwaves Through Markets

Recent movements in the bond market suggest that bond vigilantes may be reawakening. On Wednesday, the iShares 7–10 Year Treasury Bond ETF fell 0.69%, while the iShares 20+ Year Treasury Bond ETF slumped 1.71%. The selloff pushed yields higher, with longer-dated Treasurys taking the brunt of the hit. The yield on the 30-year US Treasury surged to 5.1%.

A key auction of 20-year Treasurys also disappointed, reflecting weak demand and intensifying deficit concerns. The resulting pressure extended to equity markets, which ended the day lower. Should yields continue to climb to more restrictive levels, equities may face further headwinds as valuations adjust to a higher discount rate environment.

Recent movements in the bond market suggest that bond vigilantes may be reawakening. On Wednesday, the iShares 7–10 Year Treasury Bond ETF fell 0.69%, while the iShares 20+ Year Treasury Bond ETF slumped 1.71%. The selloff pushed yields higher, with longer-dated Treasurys bearing the brunt. The yield on the 30-year US Treasury surged to 5.1%.

If that scenario unfolds, all eyes will be on the Trump administration’s response. During a previous period of bond market turbulence—dubbed “Liberation Day”—the government backed down, granting a 90-day reprieve on the imposition of reciprocal tariffs. The question now is whether renewed pressure from the bond market could prompt a rethink of the proposed tax cuts, especially given the growing strain on the federal budget.

Interestingly, if the bond market does succeed in forcing the Trump administration’s hand, it could present a buying opportunity for equities—much like it did when market pressure led to the 90-day reprieve on reciprocal tariffs.