Several structural forces appear to be driving long-term bond yields higher.
Persistently large federal deficits continue to produce enormous Treasury financing requirements. At the same time, the AI infrastructure boom is creating unprecedented private sector demand for capital as technology companies borrow heavily to finance data centers, electrical infrastructure and computing equipment.
In effect, the federal government and some of the world's largest corporations are competing for the same pool of long-term savings, which puts upward pressure on the price of capital.
The positive side of the story is that higher real interest rates (which is what we have now, given that long-term inflation expectations have been stable) tend to reflect stronger expectations for future economic growth and productivity.
Conversely, real rates tend to plunge during recessions and economic crises.
While high levels of AI-related investment are driving up the cost of capital, there is a long-term payoff. This investment may ultimately allow the economy to grow considerably faster than it has over the past several decades—and with less inflationary pressure.
But from a more short-term perspective, there are valuation consequences.
When the discount rate investors use to value future corporate earnings rises, equity valuation multiples generally come under pressure—particularly for businesses where a large percentage of expected value lies far into the future.
This is one reason the ability of companies such as NVDA to continue producing exceptional earnings growth is so important. Rising interest rates tend to compress valuation multiples, but rapidly rising earnings can more than compensate.
Treasury intervention draws attention
The rise in long-term rates became sufficiently pronounced that the Treasury Department took the unusual step of expanding its long-duration bond buyback program.
Treasury Secretary Scott Bessent announced that buyback operations involving 10- to 30-year securities would be doubled from $2 billion to at least $4 billion per operation after long-term yields surged.
The policy generated some controversy.
Famed investor Stanley Druckenmiller (who happens to have been Bessent’s mentor) argued in a widely discussed Wall Street Journal op-ed that using Treasury purchases to influence long-term yields risks undermining the credibility of the world's most important bond market.
His concern was essentially that policymakers were attempting to address a fiscal problem through market intervention rather than fiscal reform.
We would not overstate the significance of the buybacks themselves. Their size remains small relative to the enormous Treasury market.
But the episode reinforces an important point.
The long end of the yield curve is increasingly becoming a battleground between massive borrowing requirements, strong private sector capital demand, and policymakers who would prefer to prevent borrowing costs from rising too far.
This is likely to remain an important market theme, with chronic federal deficits and the tech sector’s enormous capital spending needs both creating sustained demand for long-term capital.
Warsh’s new monetary regime
The Federal Reserve added another dimension to the interest rate story in August.
At his first Jackson Hole conference as Fed Chair, Kevin Warsh again emphasized that the central bank remains committed to restoring inflation to its 2% target.
He also continued to move away from the highly explicit forward guidance that characterized much of the post-financial-crisis Fed. Markets will have to determine for themselves where interest rates should trade rather than relying on the Fed to tell them.
Investors interpreted his comments as relatively hawkish. Following the speech, market-implied odds of another September rate increase rose meaningfully. (At the moment, the implied odds of a 25 basis point hike are around 50%.)
Nonetheless, the stock market edged higher as investors focused on the strong earnings growth trajectory as opposed to upward pressure on the cost of capital.
Iran remains a wild card
Hopes earlier this summer that shipping through the Strait of Hormuz would quickly normalize have repeatedly proven premature.
Late in August, renewed military activity and continued disruption to maritime traffic pushed oil prices higher again. Oil ended the month close to $90 per barrel, versus the $80 level that prevailed at the end of July.
