Bond Market Contrarians: Why Rising Rates Threaten Trump’s Tax Reform Equity Rally

The tax reforms of 2025 have fueled a robust equity rally, with the S&P 500 surging to record highs as corporations celebrated higher profits and reduced tax burdens. Yet beneath the surface, the bond market—a historically prescient contrarian indicator—is flashing warnings. An inverted yield curve, persistent Treasury inflows, and widening credit spreads suggest investors are skeptical of the durability of this growth. For equity investors, this divergence demands attention: the party may be over before the punch bowl is empty.

The Yield Curve’s Silent Warning

The bond market’s most powerful signal—the Treasury yield curve—has been a near-perfect predictor of U.S. recessions for decades. When short-term rates exceed long-term rates (inversion), it typically signals economic contraction 12–18 months later. While the curve briefly steepened in May to a 0.45% 10Y-2Y spread, it remains perilously close to inversion after nearly two years of sporadic negative spreads.

This flattening reflects investor doubts about whether tax cuts alone can offset structural headwinds: a $1.6 trillion budget deficit, inflationary tariff pressures, and a Federal Reserve still above its long-run neutral rate of 3%. Even as Fed funds futures price in up to 100 basis points of rate cuts by year-end, the market’s skepticism is clear. The 10-year yield has hovered near 4.4%, refusing to collapse—a sign that long-term growth prospects are not as rosy as equity prices suggest.

Treasury Inflows: A Vote of No Confidence

While equities celebrate tax-driven euphoria, Treasury markets are seeing record inflows. Investors are locking in yields above 4% for long-dated bonds, a historically high rate that reflects both inflation fears and a lack of faith in equity valuations.

This divergence is no accident. Corporate tax cuts may boost earnings, but they also widen budget deficits, forcing the Treasury to issue more debt. The resulting supply pressures keep yields elevated, while credit spreads (the extra return demanded for corporate bonds over Treasuries) have widened to multi-year highs. This signals investors are demanding compensation for risks tax cuts cannot mitigate: slower growth, higher borrowing costs, and geopolitical instability.

The Sector Shift: Utilities as the New Tech

Equity investors ignoring bond market signals risk being left behind. The sectors thriving today are not the tax-sensitive tech or industrials, but rate-sensitive utilities and consumer staples—sectors with stable cash flows and dividend yields exceeding 3%, far above the S&P 500’s 1.8%.

Utilities are benefiting from a perfect storm: their low beta shields them from equity volatility, their bonds are inversely correlated with rising rates, and their regulated earnings models are recession-resistant. Meanwhile, tech stocks—once the crown jewels of tax reform optimism—are under pressure. A shows their declines tracking rising yields, as investors question whether tax savings can offset slowing consumer spending and trade wars.

The Contrarian Play: Shorten Duration, Hedge with Treasuries

The bond market’s message is clear: growth is fragile, and equities are overvalued. Investors should:

1. Rotate into utilities and REITs: Their dividends and defensive profiles offer ballast.
2. Add Treasury duration: Short-term Treasuries (1–3 years) will rise if the Fed pauses hikes, while long-term maturities hedge against recession.
3. Avoid cyclical sectors: Energy, industrials, and tech face headwinds from rising rates and slowing demand.

History favors the contrarian. When the yield curve inverted in 2006, equities peaked within 18 months. Today, with the Fed’s neutral rate at 3% and 10-year yields at 4.4%, the math suggests equity valuations are overly optimistic.

Conclusion: The Bond Market’s Clock Is Ticking

Tax reforms have given equities a sugar rush, but the bond market—the economy’s canary in a coal mine—is singing a different tune. An inverted yield curve, record Treasury inflows, and widening credit spreads are all red flags for sustained growth. Investors ignoring these signals risk a rude awakening when the Fed’s rate cuts come too late to offset a slowdown.

The time to pivot is now: shorten equity duration, favor utilities and Treasuries, and brace for a market where skepticism triumphs over hope.

Data as of May 22, 2025. Past performance does not guarantee future results.