Bonds are flashing a warning on mounting US debt and markets would be rattled if Treasury yields rise much more, market vet Ed Yardeni says

• The bond market is sending a warning on growing US debt, Ed Yardeni said.
• That's seen in rising bond yields, with the yield on the 10-year Treasury surpassing 4%.

The bond market is flashing a warning about America's debt problem, and stocks could be confronted with a sell-off as yields on Treasury bonds continue to rise, according to market veteran Ed Yardeni.

The Yardeni Research president pointed to the increasingly attractive yield on bonds, with the yield on the 10-year Treasury note clocking in at 4.213% on Wednesday. That's a sign markets are anticipating higher economic risk over the next decade – and it's largely due to America's staggering debt load, Yardeni said.

"The problem is, the bond market now cares quite a bit about the federal deficit, and as we all know, the fiscal policy is extremely profligate. We have mounting federal deficits and mounting debt," Yardeni told Fox Business on Wednesday.

The US federal debt balance hit $32 trillion for the first time this year. Growing debt is less worrying during periods of recession, as the government may ramp up spending to stimulate the economy, but debt growing rapidly while the economy is on track for a 5% expansion is concerning, Yardeni said.

Higher bond yields could also spell trouble for stocks, as they influence investors to shift away from equities and make it more expensive for companies to service their debts. The 10-year Treasury yield could potentially surpass 4.5% this year, Yardeni predicted, a move that could take the S&P 500 down to its 200-day moving average of around 4,121.

That implies a 7% downside from current levels, but a sell-off of as much as 10% is possible, he added.

"I'm a nervous bond bull because we're at a very important technical level here," Yardeni said. "It could be nasty to the upside," he added.

The Fed has signaled it could soon be ready to lower real interest rates, but sticky inflation is still a risk that could change that calculus. Investors have priced in an 89% chance the Fed will keep interest rates level at its September policy meeting, and a 21% chance the Fed could begin cutting rates early next year, according to the CME FedWatch tool.