By Min Zeng

Inflation-adjusted yields on U.S. government bonds have tumbled over the past month, the latest sign of moderating market expectations for the Trump administration's economic plan.

So-called real yields, which subtract inflation readings from the 10-year U.S. Treasury note's yield, have dropped to a recent 0.38% from 0.74% at their mid-December postelection peak. Real yields tend to rise with a strengthening economy, so the surge following Donald Trump's Nov. 8 election signaled a global expansion of economic activity was under way.

The yield decline and a recent pullback in the U.S. dollar's value suggest that investors are reassessing their initial enthusiasm for the so-called Trump trade,in which expectations of higher growth and inflation fueled sharp gains in U.S. stock indexes, the dollar and the prices of many commodities.

The real yield hit its high four days after the Dow industrials hit their all-time closing high of 19974.62, a mark the index has failed to surpass in 2017 despite several runs toward a first-ever close above 20000. On Friday, the Dow fell five points to 19885.76.

Declines in real yields and the dollar are "a sign that people are not believing that Trump policy will be able to boost economic growth, and mostly will only affect inflation," said Zhiwei Ren, portfolio manager with Penn Mutual Asset Management.

Inflation-adjusted yields measure the actual purchasing power investors obtain from investing in government bonds. When optimism toward the economy brightens, investors typically demand a higher real yield to hold Treasury debt.

The 10-year real yield remains well above its levelbefore Mr. Trump's election, 0.15% on Nov. 8. Real yields at 10 years were briefly negative earlier in 2016, reflecting fears that the global economy was headed for a long period of ultralow rates and tepid growth. Yields fall as bond prices rise.

Since the election, many have focused on Mr. Trump's proposal of large infrastructure spending, lower taxes and lighter regulation, which are expected to boost growth and inflation. Reflecting this narrative, U.S. stocks have reached record highs; the yield on the 10-year U.S. Treasury note hit a two-year high last month; and the ICE dollar index earlier this month rose to the strongest level since 2002.

The yield on the benchmark 10-year Treasury note closed at 2.38% Friday, down from its two-year high of 2.6% on Dec 16. It was 1.867% on Election Day.

Inflation expectations in the bond market have actually increased over the past few weeks.

The yield premium investors demandedto hold the 10-year note relative to the 10-year Treasury inflation-protected securities, or TIPS, has widened to 2 percentage points recently, up from 1.873 percentage point on Dec. 16. A higher premium means investors' inflation expectation over the next 10 years has increased.

"The bond market appears to be questioning Trump's policies and the execution of policy," said Sean Simko, head of fixed-income assets at SEI Investments. Before the real yields began falling, the bond market "was priced for perfect execution of everything."

Some are concerned over the likelihood of the U.S. adopting trade tariffs on imports from China. This policy option would risk retaliatory measures and hurt U.S. exports, a blow to growth momentum, while making imports more expensive in the U.S., fueling inflation pressure.

"What is his priority?" said Chirag Mirani, head of U.S. rates strategy at UBS. "Any tariffs on foreign exports into U.S. could be locally inflationary and hurt growth."

The World Bank said Jan. 10 that Trump proposals to slash corporate and personal income taxes could raise the U.S. growth rate to 2.5% this year and 2.9% next. Mr. Trump says his tax, trade and other policy proposals will generate average annual growth of 3.5% or more.

Some analysts caution against overinterpreting the market moves, which may be distorted by factors including shifts in liquidity, reflecting the capacity to trade quickly without affecting prices, and short-term positioning adjustments by hedge funds and bond traders.

Earlier this month, net bets wagering on rising yields in Treasury futures reached their highest since 2008. When many pare back these wagers at the same time, it can accentuate the pullback in bond yields.

"It is premature to say the Trump trade is over," said Priya Misra, head of global interest-rate strategy in New York at TD Securities.

But for now, many in markets are viewing the bigger risk as a scenario of moderate growth and higher inflation, which also could complicate the Federal Reserve's plan for raising short-term interest rates.

"Inflation will undermine the real incomes of U.S. consumers and force the Fed to hike rates, which could jeopardize the stock market rally and push the economy closer to an overdue recession," said Jan Dehn, head of research at asset management firm Ashmore Group.

Write to Min Zeng at min.zeng@wsj.com

(END) Dow Jones Newswires

January 15, 2017 07:14 ET (12:14 GMT)

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