While conventional wisdom attributes surging 10-year Treasury yields to inflation fears or fiscal profligacy, market models show inflation expectations and term premia have remained relatively flat. Instead, bond yields are rising because resilient nominal GDP growth—running above 6%—is forcing markets to reprice the Federal Reserve's long-term terminal rate substantially higher.
Reported US nominal GDP growth appears strong, but it is dangerously narrow. Economic expansion and employment creation are almost entirely concentrated in data center construction, power infrastructure, and hyperscaler capital expenditures. Meanwhile, key traditional cyclical economic drivers like residential construction and housing have stalled, leaving the broader economy vulnerable if AI capex growth slows down.
Massive capital expenditure projections from major technology companies do not necessarily indicate real economic output. Disclosures from hyperscalers like Amazon and Microsoft indicate that significant portions of their capital outlays are merely being absorbed by soaring memory chip prices and semiconductor supply constraints rather than higher physical build volumes or real economic productivity.
Cutting benchmark interest rates to revive the frozen residential housing market could backfire. Rate cuts would likely amplify volatility in bonds and mortgage-backed securities, causing long-term mortgage rates and Treasury yields to spike higher. Consequently, central bankers must lean into credibility and curve-flattening rhetoric to bring down the long end where real economy borrowing actually happens.
Policymaker efforts to support equity markets and ease yields are counterproductive because the economy faces severe physical capacity bottlenecks in electricity, oil, and materials. Stimulus and liquidity interventions fuel demand directly into constrained commodity supplies, sending raw material prices higher, worsening inflation, and ultimately pushing long-term bond yields higher, which crushes Main Street businesses.
Because aggregate US consumer spending is predominantly driven by the wealthiest income deciles, policy rate hikes may act as an economic stimulus rather than a restraint. Wealthy individuals hold vast cash balances in Treasury bills and money market funds. Raising short-term rates increases their cash flow income, reinforcing discretionary consumption rather than cooling demand.
Post-COVID equity rallies alongside rising bond yields propelled many US corporate defined benefit pension plans into overfunded status. With funding ratios exceeding 100% and liability growth around 3%, managers can easily achieve their required return hurdle of roughly 3.3% simply by purchasing long-term Treasuries, avoiding private equity or alternative assets and creating captive institutional demand.
Unlike Japan, which allowed currency devaluation to defend its export share, Europe is hampered by the ECB's strict price-stability mandate and Germany's balanced-budget fiscal stance. Lacking domestic AI drivers and saddled with elevated energy costs, Germany has lost global export competitiveness to Japan, resulting in a persistent post-COVID rise in corporate bankruptcies.