What is Behind the Rise in Government Bond Yields?
The 10-Year U.S Treasury Bond yield recently drifted above 5% for the first time since 2007. Over the last 10 years, we have seen multiple swings with 10-year rates rising from a local low of 1.4% in mid-2016 to a local high of 3.2% in late 2018, a subsequent plummeting of rates through 2019 into 2020 to reach a generational low of 0.5% in the aftermath of the pandemic, and the recent run-up in rates that began with the surge in inflation in 2022.
Interest rates are a composite of credit risk, inflation expectations, growth expectations, risk appetite, and opportunity cost. The increase recently is likely a combination of developments in each of these factors.
Credit Risk: As government debt balloons, the entitlements (Social Security, Medicaid, Medicare) dilemma grows (Social Security Trust Fund reserves projected to be depleted by 2032), and government spending appears to have no brakes, investors may look at the U.S. Treasury market and require some incremental yield.
Inflation expectations: With geopolitical events impacting supply chains and oil markets, we have left the 2010-2020 era of meager inflation and entered a new regime where inflation is a bit stickier and the deflationary impacts of globalization are at least being partially undone. If inflation is expected to be higher for longer, investors will require a higher nominal yield on debt instruments across the yield curve.
Growth expectations: Are we about to enter an economic boom with the proliferation of AI and the ensuing productivity gains? For those who believe so, buying a treasury bond at 4-4.5% when real (after inflation) economic growth could be 3% or more isn’t all that attractive. In addition, if investors see growth as unlikely to slow, they may be less inclined to add investments in safe havens like treasuries. Nominal GDP growth (including inflation) has averaged 6.7% since the beginning of 2022 vs. 4.1% for the period from 2011-2019. In real terms, growth has averaged 2.6% from 2022-2026 vs. 2.3% for 2011-2019.
Risk appetite: Why invest in government bonds when you can earn 15%+ per year in the stock market?? (past performance is not indicative of future performance). Again, those who see dramatic upside in the AI revolution are not likely to be buying government bonds and, on the margin, may even be selling what bonds they do have to buy more stocks. Either way, stock market booms and growing risk appetites likely spell less demand for the incremental bond issuance.
Opportunity cost: This could be another way of framing the fact that investing in government bonds has generated little return recently while riskier/high yielding bonds have generated a slightly higher return, real estate investment trusts have performed well, and stocks have returned above average. In addition, a new opportunity cost has been introduced that may be increasing the competition for buyers: cloud/AI “hyperscaler” bonds. The cloud giants like Google, Meta, and Amazon have become more frequent issuers of bonds. The six hyperscalers issued $108B of bonds in 2025 and have issued $254B in 2026 as of 8/16 (Diffusion Capital). With their fortress balance sheets, diversified businesses, cash cow businesses, and AI leverage, investors may look at bonds issues by these companies as being essentially just as safe as bonds issued by the U.S. Government. These companies are also issuing longer dated bonds, given the longer useful lives of physical property like data centers, which are likely directly competing with longer-dated treasuries. 41% of hyperscaler bond issuance across 2025/2026 has been at maturities beyond 15 years.
Effects on the Consumer
Higher long-term and short-term interest rates impact borrowing costs for businesses and consumers. Consumers continue to face higher mortgage rates (more tied to 10-year treasury yield) and higher car loans (tied to the Federal Reserve’s fed funds rate). With rates remaining higher, these areas of the economy will likely remain under pressure. Should rates fall, they may see a strong bounce back after multiple years of pressure and low affordability. Ultimately, the markets set interest rates and, as we have seen in the past, policy mishaps, sticky inflation, and/or other economic dynamics can keep rates elevated beyond where governments or consumers wish them to be. The future course of interest rates remains difficult to predict
Effects on the Investor
For investors, higher interest rates present bonds and fixed income as an incrementally attractive investment. Money market and high yield savings account rates remain elevated, providing investors with a decent return on their cash. The real yield on bonds has expanded and, for the 10 year Treasury, is the highest it has been since before the GFC. Should inflation slow and growth falter, the elevated yields would likely position longer-term bonds for strong returns. Should inflation remain high, yields may continue to trend up, but the higher starting interest rates will help protect against declines in price. For more conservative investors, or those in balanced portfolios with both stocks and bonds, higher yields and an upward sloping yield curve (longer maturity bonds yielding more than shorter-maturity) may present an opportunity to revisit fixed income and lock in attractive rates in high quality bonds.
Financial markets are complex and the rise in yields may also be due to other factors including investment decisions by large bond holders like hedge funds and foreign governments or the continued shift of institutional investor portfolios towards private asset classes. While 5% may feel high for the 10-year, that is also in part due to recency bias and the abnormally low interest rates of the 2008-2020 period during which growth was low, inflation was low, and the economy suffered two crises. In a world where real GDP growth is above 2%, inflation has been steadily north of 2%, and the competition for capital has increased amidst the AI infrastructure build out, 5% doesn't seem all that strange.
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