Most of us know the “vigilante” archetype from movies. Zorro (Don Diego de la Vega) rides in when the governor has grown corrupt. Clint Eastwood's William Munny comes out of retirement in Unforgiven to settle a score the law would not. Essentially, the vigilante shows up when the people in charge have stopped fearing consequences. The vigilante seeks to restore those consequences by force. 

Some may not know that vigilantes also exist in financial markets; specifically in the bond market. After a hiatus, they have returned this year and, depending on how one reads the data, look like they could be here for a while.  

It was James Carville, one of the most influential individuals within the US Democratic Party, who famously quipped: 

"I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody." James Carville, adviser to President Bill Clinton, 1993  

So who are the bond vigilantes exactly? And why do they hold so much power?  

The bond vigilantes

A bond is a loan. When the U.S. government needs money it cannot raise in taxes, it borrows by selling Treasury bonds to investors, who lend the money to the U.S. in exchange for regular interest payments and their principal back in the future. The interest rate the government must offer to attract those lenders is called the yield. Critically, the yield is set by the buyers rather than by the government. If investors are happy to lend, perhaps because the borrower looks very stable, they accept a low yield. If investors grow worried, whether about inflation eating into their returns or about the borrower's mounting debts, they demand a higher yield.

At base, a bond vigilante is simply an investor who refuses to lend at current rates. When enough of them refuse at once, yields rise sharply and governments suddenly find that borrowing costs far more.

Carville's quip about the power of the bond market came from experience. In 1993 and 1994, bond investors pushed U.S. 10-year yields from roughly 5% to over 8% because they doubted Washington's commitment to controlling its deficit. The Clinton administration changed course, and yields fell back. That episode (and several more since) taught politicians a lesson: you can argue with economists, but you cannot argue with your own borrowing costs.

Why the bond market intimidates 

 It might seem odd that bonds hold this much sway when stocks get all the attention. By size, the two are similar. At the end of 2025, U.S. stock markets were worth about $68.9 trillion and U.S. bond markets about $61.2 trillion. The true difference is not about size but priority. Interest on debt gets paid before shareholders ever see a cent. Thus, the price of that debt helps set the floor for many other investments. When the safest borrower in the world, the U.S. Treasury, has to pay more, most other borrowers generally do as well.  

Their price has been climbing steadily of late. On September 14, the yield on the 10-year U.S. Treasury touched 5% for the first time since October 2023. The 30-year Treasury closed at 5.27% on July 31, a level last seen in 2007, which has since moved further above 5.3%. Both are at their highest yields in about 20 years. 

The rise is not confined to the United States. Over the past year, 10-year government yields have climbed between 65bps and 141bps. China, still fighting deflation, is the lone exception. Investors are demanding more to lend to governments almost everywhere at once, which is what makes this a vigilante moment rather than a local one. 

The impact on the price of these bonds is significant. Say you bought a 10-year government bond a year ago that pays 4% interest. New government bonds now pay 5%. Thus, no buyer will pay full price for your 4% bond when they can get 5% elsewhere. If you sold it today, you would get about 7% less than you paid.  

Most other borrowing rates are set based on government bond rates, including corporate bonds, mortgages and private debt. Borrowers who haven't locked in their rates for several years will pay more interest on what they already owe and on anything new they borrow. This matters especially for AI companies, which are borrowing hundreds of billions of dollars to build data centres.

Why the U.S. is paying more

Several forces are pushing U.S. yields higher at once. 

The first is the deficit. The U.S. government borrowed $2.0 trillion in the first 11 months of its 2026 fiscal year. The Congressional Budget Office expects the full-year gap to equal about 5.8% of GDP. That is a large shortfall for an economy with low unemployment. By way of comparison, the IMF projects Canada's deficit for all levels of government combined at about 2.7% of GDP this year, against 7.5% for the United States on the same measure. 

The second is the debt those deficits have built. On August 18, total U.S. government debt passed $40 trillion for the first time, having risen by roughly $12 trillion in five years. The portion held by outside investors (which is the figure that matters for bond markets) now exceeds the size of the entire U.S. economy. Canada, by comparison, looks remarkably healthy. The IMF puts Canada's general government net debt at about 10% of GDP, the lowest in the G7 by a wide margin. On the same measure, U.S. net debt is 98.5% of GDP. Prime Minister Mark Carney recently cited this Canadian “advantage” to the European Parliament as a source of room to fund joint infrastructure projects and to support those most affected by U.S. tariffs.

10% may seem like a strangely low number given the federal and provincial deficits we are all aware of. This is because net debt subtracts a government's financial assets from what it owes. Canada's gross debt, before any assets are subtracted, is about 111% of GDP, similar to the United Kingdom's. What brings the figure down to 10% is roughly $950 billion in Canada and Quebec Pension Plan investments, which the IMF counts as government assets. No other G7 country funds its public pension this way, so no other G7 country gets this adjustment.  

Those pension assets are earmarked for retirees, meaning they are not available to pay down debt or fund new programs. As such, the 10% figure is real, but it does not mean Canada has 88bps of GDP in spare borrowing room relative to the United States. A fair reading is that Canada's fiscal position is meaningfully better than America's on both measures, though the gap on net-to-GDP is smaller than the headline number suggests.  

The third is competition for capital. The largest technology companies are borrowing on an enormous scale to build AI data centers. Fed Chair Kevin Warsh named this directly in September, saying those companies have had "so much demand for their infrastructure that they have been borrowing trillions of dollars," which adds to the pressure on bond yields generally. The four largest AI hyperscalers have had roughly $715 billion of capital spending this year, up more than 70% from 2025. Bank of America expects their bond issuance to reach $175 billion in 2026, six times the average of the prior five years. Forecasts suggest this spending will keep climbing until at least 2030. 

The fourth is inflation. The war with Iran has pushed up oil prices, and those prices have fed through to the cost of almost everything that moves. U.S. consumer prices rose 3.4% in the year to August, with energy up 16.3%. Inflation has not been at or below the Federal Reserve's 2% target since 2021. Tariffs add to the pressure by raising the cost of imported goods for American consumers. 

The fifth is the Federal Reserve itself. The Fed's new chair, Kevin Warsh, was hand-picked by President Trump and, at first, was widely expected to cut interest rates. Instead, on September 16 he and his colleagues raised the Fed's policy rate by a quarter point to a range of 3.75% to 4.00%, the first increase in three years. "Inflation is too high and has been for too long," he told reporters. Most Fed officials expect at least one more increase before year-end. The vote was unanimous, 12 to 0, which suggests this may be the beginning of more hikes rather than a one-off. 

Same yield, a very different balance sheet 

A 5% Treasury yield sounds like a return to 2007 and in one sense it is. But the government carrying that yield is in a very different position, which is why the vigilantes have more leverage this time. 

In July 2007, the Fed's policy rate was 5.25% (the overnight rate) and the 30-year Treasury (long-term rate) yielded about 5.28%. In other words, investors were paid almost nothing extra to lend to Washington for 30 years versus short-term.  

By contrast, on July 31, 2026, the 30-year yield sat roughly 1.65 percentage points above the Fed's policy rate. That gap is called the term premium; the extra return investors demand for tying their money up for decades. A rising term premium is the clearest fingerprint the vigilantes leave. 

Why higher yields feed on themselves 

Washington does not pay today's yields on all of that debt. Its borrowing cost is a blended average of bonds issued over many years, including many cheap ones from the 2010s. The average interest rate on marketable debt was 3.44% at the end of July. That average rises every time an old bond matures and is replaced at today's rates, since every maturity on the Treasury curve now yields more than 3.44%. As a rough illustration, a sustained one percentage point rise in the average rate on $32.27 trillion of debt would add about $323 billion a year in interest. 

Through the first 10 months of fiscal 2026, net interest reached about $827 billion, already the second-largest item in the U.S. budget after Social Security. There’s a potential feedback loop that can occur from this: (1) Higher yields raise interest costs. (2) Higher interest costs mean more borrowing. (3) More borrowing means more bonds for the market to absorb, which (1) pushes yields higher again. That loop is not automatic, but it is the mechanism through which bond investors’ growing concern can become a government's growing budget problem. 

 Who is still lending to the U.S.? 

Despite headlines suggesting otherwise, foreigners are not abandoning U.S. debt. Foreign holdings of Treasuries reached $9.30 trillion in June 2026, close to a record. The mix of buyers is shifting gradually, however. Foreign central banks, which hold Treasuries for reserve purposes and rarely quibble over yield, reduced their holdings over the year. Private foreign investors, who want a competitive return and will look elsewhere if they do not get one, picked up the slack. As the typical buyer becomes more price-sensitive, government bond auctions tend to clear at higher yields. The International Monetary Fund described this in April as an "erosion of the U.S. Treasury's safety premium." 

In plainer terms, the U.S. is being asked to pay more for the privilege of being the world's safest borrower. With apologies to Thin Lizzy, it’s the vigilantes who are back in town.

Two key questions to ask 

How long might this last?

When we look at the forces listed above (the deficit, the debt, competition for capital, inflation, and the Federal Reserve), none of them seems likely to improve significantly over the next few years unless the U.S. falls into a full recession. Perhaps the most important point is that a 5% 10-year yield is not abnormal. With inflation at 3.4%, a 5% yield leaves a lender with a real return of roughly 1.6%. This is close to the long-run historical norm.

What was abnormal was the period from the 2008 financial crisis to 2022, when central banks held rates near zero for over a decade. Those artificially cheap borrowing costs inflated the price of almost every asset that could be bought with borrowed money; public stocks and housing in particular. (Canadian housing has already given some of that back: the national benchmark price is down 3% from a year ago and well below its 2022 peak.)  
 
Many forecasters now believe that era is over. Apollo's chief economist Torsten Slok, for one, expects "higher-for-longer interest rates to remain" with consequences for every rate-sensitive strategy. 

How do higher rates impact other investments?

That is the more salient question and deserves a closer look at each asset class. 

Stocks: expensive by all measures 

Normally, higher bond yields take the wind out of stocks. If a government bond pays 5%, an investor needs a good reason to accept the extra risk of owning shares instead. This year that logic has not applied.  

The 10-year yield fell below 4% in late February and has since risen by more than a percentage point, yet the S&P 500 kept setting records. Low unemployment and strong corporate earnings explain part of this. However, some of those earnings come from the circular financing of the AI build-out, in which chipmakers, cloud providers, and AI developers are each other's largest customers. 

The clearest way to see how expensive U.S. stocks have become is the CAPE Shiller ratio, which compares the S&P 500's price with its average inflation-adjusted earnings over the past 10 years. Averaging over a decade smooths out booms and busts in profits, so the ratio is a fair gauge of what investors are paying for a dollar of normal earnings. It currently sits near 41. Only the dot-com bubble of 1999 and 2000 ever pushed it higher. 

Another way to compare stocks with bonds is to flip the price-to-earnings ratio upside down. Dividing earnings by price gives the earnings yield, which tells you what percentage of your money the underlying companies earn each year. The S&P 500's earnings yield has dropped from about 5% in 2022 to 3.84% today. Over the past 20 years it has been lower only twice, at the depth of the 2008 financial crisis and in the early months of COVID. Set that against a 10-year treasury yield of 5.17% (September 25, 2026) and the picture is unusual: for the first time since the depths of the 2009 financial crisis, U.S. government bonds yield more than U.S. companies earn. 

Of course, companies do not pay out all their earnings. The cash an investor actually receives from stocks comes as dividends. The S&P 500's dividend yield is 1.06%, the lowest in records going back to 1871, and below its level at the peak of the dot-com bubble. A 10-year Treasury now pays almost five times as much cash as the S&P 500.

In previous newsletters we have written about the tendency of every asset class to revert towards its long-run average return. Equities have run well ahead of their historical norm since 2022 and are expensive by any reasonable measure. This is precisely the environment in which bond vigilantes can weigh on stock returns for years, not because they sell stocks, but because they make the alternative to stocks more attractive. 

Real estate: a different relationship with rates 

Higher interest rates also weigh on real estate, but the relationship is different from the one with stocks. Property is valued using a capitalization rate (the “cap rate”) which is a building's annual net rental income divided by its appraised price. Cap rates tend to follow bond yields, because a buyer who can earn 5% on a Treasury will not accept 4% on a building with tenants to manage. When cap rates rise, property values fall, all else being equal. 

However, all else is not always equal. If yields are rising because of inflation, rents tend to rise too. Higher rental income can partly or fully offset the drag from a higher cap rate. CBRE's mid-year survey captures this effect. Despite a volatile first half in which the 10-year yield rose substantially, the all-property average cap rate was essentially flat. 

That said, U.S. commercial real estate has already been through a correction. The NCREIF Property Index, which tracks institutional-quality U.S. property, turned negative in 2023 for the first time since 2009 and barely recovered in 2024. Higher rates are likely to delay the recovery in total returns rather than trigger a fresh decline. Over long periods, real estate has been one of the more reliable hedges against rising inflation.

Fixed income: why we’re staying short for now 

Long-dated bond funds (those holding bonds that mature in 10 years or more) have posted negative returns in 2026 and muted returns since 2023. The reasons are 2 rules that every bond investor learns early: (1) When yields rise, the prices of existing bonds fall and (2) The longer the bond, the harder it falls. Given the pressure the U.S. Treasury faces at future auctions, we may not have seen the end of rising yields, especially on 30-year bonds. 

Canada is in a stronger fiscal position and its yields are lower. On July 31, Canada's long-term benchmark yield was 4.04% against 5.27% for the U.S. 30-year. Canada also retains top credit ratings: Aaa from Moody's, AAA from S&P and Morningstar DBRS, and AA+ from Fitch (while the U.S. has lost its top rating from all three major agencies). The catch is that Canadian yields track U.S. yields closely. If the gap between them widens further, that tends to weaken the Canadian dollar, though not always. 

Through the 1990s, Canada paid nearly a full percentage point more than the U.S. to borrow for 10 years, a legacy of the deficits and credit downgrades of that era. The relationship flipped in the 2010s where it has stayed since. As of September 18, 2026, Canada's 10-year yield was 3.97% against 5.18% for the U.S., a gap of 1.21 points in Canada's favour. 

We believe, the safer decision today is to keep the duration of fixed income short. Duration measures how sensitive a bond's price is to a change in yields; a duration of two years means a +1% rise in yields costs roughly 2% of value, whereas a duration of 15 years would cost roughly 15%.  

Across our fixed income holdings, we have kept most of our interest rate exposure short by keeping low fund duration. As of September 28, 2026, Nicola Canadian Mortgage fund and Nicola US Mortgage fund both carry durations below 3 years. Nicola Private Debt fund has 97% of its loans at floating rates, effectively below 1 year duration. Nicola High Yield Bond fund favours high-quality issuers and, in general, high yield bonds have less interest rate sensitivity than investment grade bonds. Its effective duration is roughly 2 years. 

Nicola Bond fund is where we have chosen to hold more duration, at a weighted average of about 4.7 years. This is longer than the short-term Canadian bond index but shorter than the broad index. With several rate hikes already priced into five-year yields, we believe current yields pay us fairly for that risk. Holding some duration also protects the portfolio if the economy slows, since bond prices tend to rise when growth weakens and rates fall. If long-term yields keep rising faster than short-term yields, we would then look to add longer bonds. 

Alternatives: where higher rates help and hurt 

Private equity has not matched the returns of public markets in recent years. Higher rates reduce the benefit of leverage, which many private equity funds rely on to amplify returns. For funds that use little or no borrowing, higher inflation should offset much of the drag from higher rates, since the businesses they own can raise prices. 

Infrastructure is the asset class we find most attractive in this environment. Toll roads, utilities, pipelines, and data transmission tend to carry contracts that adjust with inflation. Already this year, their returns have been less volatile than private equity. Sovereign wealth funds and large pension plans around the world are competing for these assets, which supports their value. We wrote about this at length in our recent piece on the infrastructure cycle.  

What this means for portfolio defence 

For much of the past 40 years, investors could count on a simple relationship: When the economy weakened, interest rates fell, bond prices rose, and government bonds cushioned the fall in stocks. A balanced portfolio of stocks and bonds did what it was supposed to do.  

The next downturn may not follow that script. A recession would likely still push yields down through Fed rate cuts and safe-haven buying. But it would also widen the deficit since tax revenues fall and spending on programs such as unemployment benefits rises. More borrowing means more bonds to sell, which pushes yields the other way. As recently as 2022, when stocks and bonds fell together, we saw a preview of how that tug-of-war can play out. 

We are not arguing against owning bonds or stocks. We are arguing against relying on any one relationship, or any one asset class, to defend a portfolio. Our approach at Nicola Wealth is to hold assets that do well under several different futures: real estate and infrastructure for inflation-linked income, private and floating-rate credit for higher coupons when rates stay high, shorter-duration bonds that lose little if yields keep rising, and global holdings that add return when the Loonie weakens. When one part of the portfolio meets a headwind, another is usually catching a tailwind. 

We began with the return of the bond vigilantes. Most of the time they are absent from markets and it is easy to forget they exist. Yet, they always return when the cost of money is being taken for granted. And they do not tend to leave until it is priced properly again. In the end, we think this tends to lead to better fiscal and corporate discipline. 

Part of the vigilante's job is to bring the powerful to heel by making them accountable. Whether this is one of those moments will become clear soon enough. In the meantime, a portfolio built for uncertainty from the outset does not need to make correct guesses to be successful. 

If you are unsure how your portfolio would hold up in a world of persistently higher rates, schedule a meeting with your advisor today.