Treasury bond yields of all maturities have been climbing higher in recent months. As an example, the 30-year Treasury reached a yield of 5.3% in August, a level not seen since 2006.
What investors are seeing in Treasury markets is less about a single concern or a looming crisis, and more about a confluence of factors that are reshaping global markets. Taken together, these factors are forcing markets to wrestle with a complex question: What is the appropriate cost of capital in this new regime, when easy money is a thing of the past and many demands are being placed on the world’s savings at the same time?
What’s been driving rising Treasury yields
I believe there have been several overlapping factors at play in the recent volatility in Treasury rates:
1. Higher economic growth expectations
One factor is higher expected economic growth. Stronger growth drives up the neutral rate of interest for an economy. This rate, known as R* (pronounced "R-star"), is the economy's natural equilibrium rate.
The AI capital expenditure boom, which started in earnest earlier this year, is proving a tailwind to the overall US economy and does not appear to be waning anytime soon. In the near term, the capex boom is helping stimulate the economy by increasing aggregate demand for equipment and goods related to this buildout. Longer term, the market is hopeful that the technology ultimately proves transformational for growth—boosting productivity the way railroads did in an earlier era.
The timing of any eventual sustained uptick in productivity-led economic growth is highly uncertain, but research by Fidelity’s Asset Allocation Research Team (AART) shows that productivity gains can be realized over a 10- or 15-year time horizon. The bond market is trying to price in that future growth today, which helps partially explain the recent rise in yields.
2. Elevated and volatile inflation
Another important factor is inflation.
Inflation has moderated from the extreme levels experienced earlier this decade, but it remains elevated and has proven more persistent than many investors expected. Geopolitical events, generally tight labor markets, supply-chain and energy-market disruptions, and strong investment spending have all contributed to an environment in which inflation risks remain higher than they were during much of the post-Global Financial Crisis era.
For bond investors, inflation matters because it erodes the future purchasing power of a bond's fixed payments. As such, when inflation is elevated, investors typically demand higher yields as compensation. The uncertainty of the path of inflation, coupled with questions about the AI investment boom and potential future productivity, has contributed to an ongoing reassessment of where long-term interest rates should settle.
In the near term, AI-related capital spending is increasing demand for chips, energy, and other resources, potentially adding to inflationary pressures. Over the longer term, however, the technology could prove productivity-enhancing and ultimately disinflationary.
Finally, investors are grappling with uncertainty over how the Federal Reserve will respond to those competing forces.
3. Competition from private-sector borrowing
It’s no secret that the US runs a substantial fiscal deficit, currently at 6% of gross domestic product (GDP). The federal government’s borrowing needs aren’t new, and the market has readily absorbed Treasury issuance for many years. But one thing that’s changed is that this borrowing must now compete with a historic wave of private-sector debt issuance.
For years, many of the large technology companies driving today's AI revolution were cash-flow positive—generating vastly more cash than they could reasonably deploy. Today, many of those same companies have become borrowers, and are now issuing large amounts of debt to finance their investments in data centers and related infrastructure. The pace of new borrowing has become particularly heavy since late spring. Bond issuance by companies in the tens of billions of dollars is now relatively commonplace.
That issuance has drawn investor attention away from Treasury markets. For the first time in many years, the US government is competing with some of the world’s largest companies—which typically offer a spread on top of Treasury yields (meaning, slightly higher interest rates)—for the same pool of capital.
4. Major shifts in global dynamics
The US does not save enough domestically to finance all its investment and borrowing needs. It remains reliant on foreign capital. This means that geopolitics and economic conditions abroad can influence interest rates on US Treasurys.
Many geopolitical developments have been accumulating in the last decade without much fanfare in the market, but their effects may now be starting to surface. As tensions have risen among major global powers and some nations have sought to assert their independence from US influence, certain global investors have taken a step back from the Treasury market. Meanwhile, aging populations and the demands they place on public safety-net spending are pressuring government finances across the developed world. Finally—after the experiences of COVID, the Ukraine War, heightened geopolitical instability, and recent energy-market disruptions—many countries are spending more on their militaries, reshoring supply chains, and investing in greater energy independence.
The global pool of savings is finite, but the demands on that capital are growing.
One surprisingly important piece of the global puzzle is Japan. For decades, Japan held interest rates at an ultra-low level as the country battled deflation—resulting in Japanese investors seeking higher returns abroad. Over time, Japan became one of the most significant buyers of overseas assets—supporting demand for US Treasurys and other global bonds—and acting almost as an anchor on yields around the globe.
In recent years, Japan has begun to normalize interest rates, meaning more of its investors’ capital may have a reason to stay closer to home. This could mean less support for Treasurys and other global bond markets.
5. US policy uncertainty
Another factor may be the uncertainty surrounding how US policymakers will respond to these developments.
Long-term bond investors are not simply focused on today's economic conditions. They are also trying to assess the future path of fiscal policy, debt management, inflation, and interest rates. When the outlook becomes less predictable, investors often demand additional compensation for holding long-term bonds.
In recent months, markets have had to digest a wide range of signals related to Treasury financing, monetary policy, and government borrowing. Higher rates do not necessarily imply that markets expect a negative outcome. But when investors have less confidence in the range of potential outcomes, they often demand a higher premium to lend money for long periods of time.
Rising rates are not necessarily cause for alarm
Headlines about rising deficits might make investors fear a looming crisis. I believe the actual picture is less sensational and more mechanical. Yields are changing in order to match the supply of bonds with investor demand for bonds, and there is nothing unnatural about this.
The composition of global Treasury investors has shifted over the years from reserve managers at central banks, who were price-agnostic buyers of Treasurys, to private institutions, which are price-sensitive buyers. In other words, typical Treasury investors today are not automatic buyers of Treasurys, as they have been in the recent past. The marginal buyer of debt today might be a pension manager in Australia or an insurance company in Japan. These investors want to make sure they are getting a competitive rate of return on their investments, all things considered, and have many investments to compare Treasurys against.
Right now, these investors are asking what return they should be demanding on US Treasurys—given all the forces at play.
The economy continues to show resilience
The broader economic backdrop remains constructive. I continue to view the economy as being firmly in a mid-cycle expansion. The labor market remains healthy, consumer spending has proven resilient, and corporate profit growth has continued to defy expectations, in no small part thanks to the tailwind from AI-related investment spending.
This is not to say the economy is perfectly balanced or is benefiting all consumers equally. It has become very dependent on wealthier consumers, reflecting the uneven nature of today’s so-called K-shaped economy. But it means I'm seeing few warning signs of recession risk.
The real risk posed by rising Treasury yields
In my view, the risk to watch is not that investors suddenly lose faith in the US government's ability to meet its obligations. It’s that higher bond yields begin to compete more directly with stocks for investor capital.
The higher bond yields go, the more attractive they begin to look relative to stocks. In recent years, many investors have reduced their bond allocations during the low-rate regime. Going forward, if bond yields continue to rise, this may incentivize investors to shift some of their historically elevated stock allocations back toward fixed income. Therefore, Treasury rates may put pressure on stocks as bonds become increasingly attractive.
Currently, investors are optimistic about the AI trade, which gives them an additional reason to choose stocks over bonds. But if cracks in that optimism eventually emerge, higher yields could lead investors to reallocate some money from stocks to bonds.
Treasury volatility may remain a theme
The bond market is not simply reacting to deficits. It is trying to price a world of larger investment needs, shifting global capital flows, changing growth and inflation expectations, and intense competition for a limited supply of savings.
Some of these forces may ebb and flow—for example, greater clarity on Japanese interest rate policy could ease one source of volatility—but they are unlikely to disappear anytime soon.
Yet investors should remember that changes in interest rates are a normal by-product of the market’s role in matching supply and demand. Higher interest rates may feel abnormal compared with the low-rate, easy-money conditions of recent decades, but this is the new regime we’re in.
Kana Norimoto is a Managing Director of Asset Allocation Research in the Global Asset Allocation division at Fidelity Investments. Fidelity Investments is a leading provider of investment management, retirement planning, portfolio guidance, brokerage, benefits outsourcing, and other financial products and services to institutions, financial intermediaries, and individuals. Global Asset Allocation (GAA) is an investment team within Fidelity's Asset Management Solutions division, an investment organization that provides industry-leading multi-asset solutions to the retail and institutional marketplace.
In this role, Kana is responsible for leading the Asset Allocation Research Team, which conducts fundamental and quantitative research to develop asset-allocation recommendations for Fidelity's portfolio managers and investment teams. The team generates insights on macroeconomic, policy, and financial market trends and their implications for strategic and active asset allocation.
Prior to assuming her current role, Kana was a macro research analyst in the Fixed Income division at Fidelity Investments. In this role, she was responsible for analyzing the economies of the United States, China, and Japan through a fixed-income lens, with a focus on the monetary policies of central banks in these countries. She was also responsible for research on the credit cycle and understanding global capital flows that drive returns on fixed-income assets. Previously, Kana was a fixed income bank analyst covering UK, Japanese, and Singaporean banks in Fidelity's London office. Before joining Fidelity, she worked as a research analyst covering European banks in developed and emerging markets for Citigroup in London from 2002 to 2008. Prior to that, she was based in Japan, covering Japanese banks for Nikko Salomon Smith Barney from 1999 to 2002. Kana also worked as an associate analyst covering U.S. and Japanese banks for Salomon Brothers in New York from 1995 to 1999. Kana joined Fidelity in 2008 and has been in the financial industry since 1995.
Kana earned her Bachelor of Arts from Smith College and her Master of Arts from Columbia University.