Higher-than-expected inflation data drove bond yields higher and roiled stocks Wednesday. The main indices shook off inflation fears and closed in the green, but not before another day of choppy trading.

Rising bond yields took center stage today. The bond market increasingly calls the shots. History is repeating itself.

Back in 1993, Clinton political adviser James Carville said:

“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.”

President Bill Clinton was more profane:

“You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of [expletive deleted] bond traders?”

From October 1993 to November 1994, 10-year Treasury yields climbed from 5.2% to over 8%, fueled by worries about federal spending. It became known as the Bond Market Massacre.

The resulting investor anxiety was similar to what we’re experiencing today. The dynamic gave rise to another term: Bond Vigilante.

Bond Vigilante describes a bond market investor who protests monetary or fiscal policies he considers inflationary by selling bonds, which in turn boosts yields. In the bond market, of course, prices move inversely to yields.

In response, the Clinton administration worked with Congress to lower the federal deficit. It worked. By November 1998, 10-year yields dropped to about 4%. Calm was restored.

Back in the saddle…

The vigilantes are saddling up again. Whether they can spur divided lawmakers into action this time is doubtful.

The U.S. Labor Department reported Wednesday that consumer prices rose considerably more than expected in January. It was an unpleasant Valentine’s Day surprise. The yield on the 10-year Treasury note immediately jumped.

The Consumer Price Index (CPI) rose 0.5% last month against projections of a 0.3% increase. Excluding volatile food and energy prices, the CPI was up 0.3% versus estimates of 0.2%. The government report noted that price pressures were broad-based.

Also on Wednesday, the U.S. Commerce Department reported that business inventories rose 0.4% in December after a similar gain in November. The number exceeded expectations and provided further confirmation that growth remains on track. The economy grew at a 2.6% annualized pace in the final three months of 2017.

Wall Street interpreted the latest government data as a sign that the Federal Reserve would hike interest rates at least four times this year instead of only three as originally planned. The betting is for a 25 basis point rise in rates at the next Federal Open Market Committee meeting in March.

U.S stock futures plunged more than 1% after the inflation data was released today at 8:30 a.m. ET. An hour later at the opening bell, the stock market opened in the red. As the day wore on, stocks gained traction. But rising bond yields indicate that inflation worries will persist.

Bond yields have been moving higher since autumn. The 10-year Treasury yield topped 2.91% today, a four-year high.

Earnings take a back seat…

According to data from FactSet, corporate earnings have been stellar in the fourth quarter. With 68% of S&P 500 firms reporting actual results for the quarter, 74% have reported positive earnings per share surprises and 79% have reported positive revenue surprises.

The blended year-over-year earnings growth rate for the S&P 500 in the fourth quarter is 14%. All eleven sectors are reporting earnings growth.

But rising bond yields have been “trumping” (pun intended) strong earnings.

According to the bipartisan Committee for a Responsible Federal Budget, the new tax overhaul package will push the federal deficit to over $1 trillion in 2019.

The federal government must issue bonds to finance that deficit. Making such a large amount of bonds attractive to buyers will require higher yields.

Higher bond yields boost borrowing costs; economic growth and corporate profitability suffer. Higher yields also make bonds a more attractive alternative to riskier stocks — and they make excessive equity valuations harder to justify. Stocks rose today, but the vigilantes are tightening the noose.

Wednesday Market Wrap

• DJIA: +1.03% or +253.04 points to close at 24,893.49
  
• S&P 500: +1.34% or +35.69 points to close at 2,698.63
  
• Nasdaq: +1.86% or +130.10 points to close at 7,143.62
  

Wednesday’s Big Gainers

• ACCO Brands (NYSE: ACCO) +16.59%

Consumer branding firm beats on earnings.

• Twilio (NYSE: TWLO) +16.23%

Cloud services provider posts solid quarterly results.

• 22^nd Century Group (NYSE: XXII) +9.25%

Biotech makes progress on marijuana research.

Wednesday’s Big Decliners

• GNC Holdings (NYSE: GNC) -15.55%

Analysts turn sour on wellness retailer’s merger with Chinese drug firm.

• Luxoft Holding (NYSE: LXFT) -13.23%

IT firm reduces guidance.

• Kemper (NYSE: KMPR) -6.78%

Wall Street negative on insurer’s buyout of rival.

Letters to the Editor

“Why is higher-than-expected inflation a problem?” — Tim S.

Rising inflation eats into investment gains and erodes purchasing power. Retirees on fixed incomes suffer when their nest eggs buy less every year.

Price growth that’s higher than expected, as we saw today, is even more painful. It takes companies several quarters to pass along higher input costs to consumers. In turn, consumers face sticker shock when purchasing goods and services.

Income-generating stocks get hit especially hard. Dividends typically don’t keep pace with inflation levels. The taxation on dividends creates a double-negative effect.

Got questions about inflation? Send me an email: mailbag@investingdaily.com

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.