Why falling government bond yields require an economic downturn: An analysis

President Donald Trump’s administration’s policies are helping to keep bond yields high, even as the White House itself seeks to lower them. Since the 80-year-old president is unlikely to leave office, Americans may not like what is needed to ease interest rates. It’s an economic downturn that is hurting U.S. growth while cooling borrowing costs.

The investor base for U.S. Treasuries has become more price-sensitive in recent years, as central banks and reserve holders have become less buyers than some private sectors. Some global investors are starting to shy away from U.S. Treasuries as policy changes under President Trump have had a deteriorating effect on economic conditions. This is a jarring development for a market that is already showing signs of competition for capital between a flood of deficit spending and a surge in bond issuance to fund the build-out of artificial intelligence.

yield of 10 year US bond It has risen about three-quarters of a percentage point over the past six months. Despite efforts to lower interest rates, they have recently hovered around 4.8%, the highest yield during the second Trump administration. Next week, the Treasury will begin expanding buybacks of some long-term U.S. Treasuries to improve market liquidity. Investors are also raising interest rates as they try to speculate how new Federal Reserve Chairman Kevin Warsh will react to inflation that remains above the Fed’s 2% target.

“Obviously everyone wants a little bit higher price to lend money to the U.S.,” Ludovic Soubran, chief investment officer and chief economist at European insurance company and asset manager Allianz, said in an interview.

Sablan said the decision was not political, but based on “pure economics.”

Sablan cited a series of factors that have added some semblance of credit risk to the U.S. debt: “the skyrocketing[federal budget and trade]deficits, the inflation-inert Fed, and the Treasury’s market manipulation.” He doesn’t necessarily believe the U.S. will default on its debts, but said Allianz, like many other global investors, has had to pay more money to hedge its bets in the United States.

The United States is expected to reach the $41.1 trillion debt ceiling by late winter to mid-summer 2027.

This year, Sablan said, “we also decided not to find duration in the U.S. bond market as we have in the past because it’s not interesting.”

After accounting for inflation and hedging, “we weren’t making a profit,” he said.

Rising yields are making matters worse for Americans already frustrated with affordability issues. Mortgage interest rates rose to nearly 6.8%. Mortgage interest rates fluctuate in conjunction with the 10-year government bond yield. The same goes for car loans and other forms of consumer debt.

There is little sign that the political forces driving yields are easing. While falling oil prices may bring some relief, there is still no end to the Iran war in sight. There is no appetite in Washington for political compromises that would ease deficit spending. A meeting of global finance ministers and central bank governors in North Carolina this week sparked political fire against Canada. Concerted action to ease borrowing costs was not on the agenda.

Meanwhile, some large holders are considering moving away from U.S. Treasuries and into higher-yield bonds. Norway’s giant sovereign wealth fund is considering moving about $80 billion of its current portfolio of government bonds into other parts of the bond market, such as mortgage-backed securities.

Meanwhile, US government borrowing continues to increase. The Congressional Budget Office recently had to revise upward its deficit forecast for this year to $2.1 trillion, a number likely to exceed 6% of gross domestic product. This is a huge amount of borrowing outside of a crisis.

AI is also driving new large-scale corporate borrowing. JPMorgan estimates that the five largest tech companies, Nvidia, and the special-purpose vehicles they use to backstop data center leases have issued about $320 billion in debt so far this year.

“Hyperscalers are issuing so much debt that they may be creating supply and demand issues at the long end of the yield curve,” Michael Cembalest, chairman of markets and investment strategy at JPMorgan Asset Management, said in a letter to clients this week.

That’s not necessarily a bad thing. AI is a bright spot in a U.S. economy that is hurting its sources of growth. Gross domestic product (GDP) grew 1.5% in the second quarter, lower than expected, likely due to a sharp slowdown in immigration to the United States following President Trump’s crackdown. The labor market has also been showing abnormal movements recently. Friday’s report that payrolls rose by 162,000 goes against a long-term environment in which companies have been reluctant to hire or fire.

Competition in the bond market could fuel an innovation boom as companies vie for market support. Although it is too early to tell the final verdict, the possibility of this kind of growth and productivity boom is one explanation for the rise in real yields that adjust for inflation.

The 10-year TIPS yield on U.S. Treasuries, adjusted for inflation, rose 67 basis points over the past six months to 2.43% on Thursday, according to FactSet data. The break-even point, which measures inflation, has remained flat over the same period.

New York Fed President John Williams told CNBC on Wednesday that the rise in real yields “rather reflects the strength of the economy.” While some people like to interpret rising yields as a drag on the economy, the logic is the opposite, he said.

“This is not about financial conditions influencing the economy, but rather the economy influencing financial conditions,” Williams said.

The flip side of Williams’ analysis is that the economy may need to slow for borrowing costs to come down. But that’s not a solution everyone wants to support.