Bond Yields Surge to Multi-Decade Highs on AI Debt
Government borrowing costs from the US to Japan have hit their highest levels in decades.
Government bond yields in the US, France, Britain, and Japan have reached levels not seen in decades, driven by a confluence of fiscal, monetary, and structural pressures. The 10-year US Treasury yield hit 5.34% on Thursday, its highest since 2002. That yield posted the biggest quarterly rise so far this century in the third quarter, climbing almost 90 basis points. Britain's 30-year borrowing costs touched 6% for the first time since 1998, while French 10-year yields are at peaks last seen in 2002.
AI Boom Fuels Unprecedented Debt Issuance
The surge in AI-related spending has led hyperscalers to issue record levels of debt, adding to global bond supply and exerting upward pressure on yields. Five of the biggest AI firms have issued $220 billion of debt already this year to fund investments in data centres and models, according to LSEG data. This figure is more than double last year's total. More AI-related debt issuance is expected in coming months. The enormous funding demand from the sector marks a structural shift from the pre-pandemic period of surplus savings and is pressuring interest rates higher.
Fiscal and Inflationary Pressures Persist
High government debt levels, stubborn inflation, and expansive fiscal policies are combining to keep yields elevated. US debt has topped $40 trillion, and debt as a share of economic output is at or above 100% across the G7, except Germany. Britain's interest bill is almost 4% of output, roughly double its pre-pandemic average. Major economies now spend more on interest expense than the world invests in either AI, defence, or clean energy.
Many investors say the current rise reflects higher borrowing and inflation. A renewed rise in oil prices on US-Iran tensions is driving yields higher as traders brace for more interest rate hikes. Even a milder US inflation print is not enough to turn the narrative. There are lingering doubts whether central banks will ever get ahead of the curve. Expansionary fiscal policies are equally to blame for persistent inflation. A slight upside or downside surprise in a single inflation reading is a necessary but hardly sufficient condition to bring yields back down swiftly.
Markets Await Fiscal Discipline as Bond Vigilantes Watch
With central banks limited and governments showing no sign of spending cuts, investors remain wary. The term 'bond vigilantes' refers to investors who seek to impose fiscal discipline on governments they perceive as profligate by demanding higher yields. The European Central Bank has the power to buy government bonds under certain conditions to stem an 'unwarranted, disorderly' rise in costs. Bank of France Governor Emmanuel Moulin said last week that "it would be misguided to expect the ECB to ride to the rescue of a selloff in French bonds."
In contrast, US Treasury Secretary Scott Bessent said "worries about rising debt and yields overlook the strength of the US economy." The US Treasury recently announced bond buybacks aimed at limiting rising borrowing costs. However, there has been no sense that spending cuts are on the agenda. In France, populist parties are gaining traction. Analysts point to the laws of supply and demand: a jump in the need for borrowing lets lenders demand higher rates.
Rising yields set the tone for borrowing costs across economies, from government debt to mortgages. The rate on the most popular US home loan pierced the 7% level last month for the first time since early 2017. Higher yields can make stocks less attractive, though strong earnings have kept equities buoyant. Some investors, such as multi-market hedge funds, could come under pressure. Falling oil prices would help short-term, but longer-term borrowing costs will only come down durably once governments take concerted steps to bring down debt or boost growth. Unless governments take hard decisions to cut spending, bond vigilantes will remain on alert.
