Fear of Inflation Finds a Foothold in the Bond Market

The so-called bond vigilantes may be back, 30 years after they led a sell-off in Treasury securities over the prospect of higher government spending by a new Democratic administration.

The Federal Reserve has downplayed the risk of inflation, and many experts discount the danger of a sustained rise in prices. But there is an intense debate underway on Wall Street about the prospects for higher inflation and rising interest rates.

Yields on 10-year Treasury notes have risen sharply in recent weeks, a sign that traders are taking the inflation threat more seriously. If the trend continues, it will put bond investors on a collision course with the Biden administration, which recently won passage of a $1.9 trillion stimulus bill and wants to spend trillions more on infrastructure, education and other programs.

recall the 1990s, when yields on Treasury securities lurched higher as the Clinton administration considered plans to increase spending. As a result, officials soon turned to deficit reduction as a priority.

coined the term bond vigilante in the 1980s to describe investors who sell bonds amid signs that fiscal deficits are getting out of hand, especially if central bankers and others don’t act as a counterweight.

As bond prices fall and yields rise, borrowing becomes more expensive, which can force lawmakers to spend less.

“They seem to mount up and form a posse every time inflation is making a comeback,” Mr. Yardeni said. “Clearly, they’re back in the U.S. So while it’s fine for the Fed to argue inflation will be transitory, the bond vigilantes won’t believe it till they see it.”

Yields on the 10-year Treasury note hit 1.75 percent last week before falling back this week, a sharp rise from less than 1 percent at the start of the year.

plenty of slack in the economy.

That’s how Alan S. Blinder, a Princeton economist who was an economic adviser to President Bill Clinton and is a former top Fed official, sees it. Even if inflation goes up slightly, Mr. Blinder believes the Fed’s target for inflation, set at 2 percent, is appropriate.

“Bond traders are an excitable lot, and they go to extremes,” he said. “If they are true to form, they will overreact.”

Indeed, there have been rumors of the bond vigilantes’ return before, like in 2009 as the economy began to creep out of the deep hole of the last recession and rates inched higher. But in the ensuing decade, both yields and inflation remained muted. If anything, deflation was a greater concern than rising prices.

It is not just bond traders who are concerned. Some of Mr. Blinder’s colleagues from the Clinton administration are warning that the conventional economic wisdom hasn’t fully accepted the possibility of higher rates or an uptick in prices.

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Robert E. Rubin, Mr. Clinton’s second Treasury secretary, echoed that concern but took pains to support the stimulus package.

“There is a deep uncertainty,” Mr. Rubin said in an interview. “We needed this relief bill, and it served a lot of useful purposes. But we now have an enormous amount of stimulus, and the risks of inflation have increased materially.”