Plotting the yields of bonds with different maturities will give a yield curve which has three main shapes:
1. Normal – upward-sloping
2. Inverted – downward-sloping
3. Flat – self-explanatory
A normal yield curve shows lower yields for shorter-maturity bonds increasing for bonds with longer maturity (due to mainly inflation and risk). An upward sloping curve indicates interest rates are expected to rise, responding to periods of economic expansion. The steepness of the normal yield curve indicates the level of growth (e.g., high growth creates high inflation and high interest rates).
Similarly, a flat yield curve indicates that investors expect interest rates to stay about the same. This normally indicates that markets are uncertain, often a transition point between inverting or steepening.
An inverted yield curve occurs when short-term yields exceed long-term yields, suggesting a future fall in interest rates, typically responding to a period of economic recession when investors expect yields on longer-term maturity bonds to trend lower in the future.
Bond yields have significant impact on economic agents:
Bond yields and the yield curve give an adequate prediction of future macroeconomic conditions, as the yield curve reflects a combination of inflation expectations, policy outlook and investor sentiment. Not bad for a single asset. However, the true story lies in our understanding of that asset: Is it a thermometer indicating a feverish economy, or is it a smoke detector that is more likely to go off in error? Bonds deliver signals, but not always the signals policymakers want to receive.
Bonds don’t only respond to interest rates and inflation: they can also be guardians of policy making and fiscal discipline. The so-called “bond vigilantes” describe investors who sell off bonds in response to what they deem too inflationary. A mass sell-off reduces the price of bonds, increasing their coupon rates, which makes it more expensive for governments to borrow money.
An example of this was in 1993-1994 (Clinton administration), where bond investors were frustrated with the huge government spending that was occurring. As a result, the sell off drove up the yields on 10-year Treasuries from 5% to 8%. These yields fell once Clinton got rid of his plans for national health insurance reform and his series of more conservative policies.
A similar thing happened in response to Trump’s ‘Liberation Day’ on the 2nd of April 2024 – 10-year Treasury bond yields jumped 0.11 percentage points in less than a year and after a US Treasury Department auction for three-year bonds “attracted the weakest demand since 2023”. Trump himself called the bond market “yippy”, prompting his 90-day pause (Katie Martin, 2025).
Despite yields rising quite dramatically, they were never close to reaching historical peaks, as shown by the graph. So why are these ‘bond vigilantes’ holding back? Fundamentally, the strength of the US dollar creates very low risk. Even the potential of Trump’s One Big Beautiful Bill to add $3.3 trillion to the deficit doesn’t trump the dollar’s unique property as a world reserve currency, and therefore (as it won’t particularly affect interest rates) investors, who are mainly just concerned with getting paid, have no reason to sell off their bonds.
Therefore, the theory of a group of ‘bond vigilantes’ controlling the government’s policies by selling off bonds in times of unfavourable fiscal policy is becoming less credible with the growth of digitalised banking and the ease of obtaining assets (Ugo Panizza, 2025). In summary, the U.S. has a 'get out of jail free card', and that card is the dollar. Bond investors can complain all they want about additional spending, but as long as they believe that America will pay them back, the dog rarely bites. The vigilantes are not dead; they are just dollar-blind.
The UK bond market was deemed the ‘most sensitive developed market’ by Fredrik Repton, a senior fixed income portfolio manager, meaning it responds quickly to times of political uncertainty. Recently, bond markets were rattled after Reeve’s emotional episode and Starmer’s initial failure to strongly back her. This threatened Reeve’s resignation and fiscal discipline – “Such fiscal discipline would follow her out of the door,” said Andrew Wishart, an economist at Berenberg Bank (Ian Smith, 2025).
The effect sent 10-year gilt yields up by 0.23 percent to a high of 4.68% and came back down to 4.55% after Starmer said she’d be around for “a very long time to come”. This demonstrates how bond markets reflect fiscal credibility and political instability and how quickly investors can sell based on political episodes (Ian Smith, 2025). The UK faces a challenge when compared to the US, in that it does not enjoy the benefits of being a reserve currency. Mistakes aren't forgiven here but are punished in real time. In a global economy where optics move markets, even tears from a minister can shake the yield curve.
So, do ‘bond vigilantes’ really exist? Well, not to the extent that some think. As seen, bond yields can react adequately to political events that may affect the future return on bond yields. While the myth of bond vigilantes as powerful fiscal enforcers may be overstated, bond markets do respond to perceived fiscal irresponsibility, as seen recently in the UK. However, the US bond markets being seemingly tame in response to Trump’s questionable policies demonstrates that investors fundamentally only care about their return. So, we may be seeing a new type of ‘bond vigilantes’ that are more reactive but tamer. Modern-day vigilantes are not about discipline as much as they are about containment. They will not deport governments, but they will at least send a message. And in politically precarious situations, that's sufficient to take a toll.
Bonds are a crucial part of a financial system, and their responsiveness to various macroeconomic indicators makes them an insightful forecast indicator. While the notion of shadowy ‘bond vigilantes’ enforcing fiscal discipline may be fading, markets still can respond quickly to unfavourable political and economic policies. Therefore, bond yields remain a powerful, if quieter, check on policy credibility.