Why 5% Treasury Yields May Be Just the Beginning

Trumponomics

The episode examines the recent breach of the 5% threshold in US 10-year Treasury yields and explores whether this represents a temporary spike or a permanent

Key takeaways

• The US 10-year Treasury yield reached 5.04%, marking its highest level since 2007.
• John Authers compares the scale of private sector investment in AI data centers to the Marshall Plan or FDR's New Deal.
• Jamie Rush identifies demographic shifts and rising productivity from AI as key drivers for increased demand for capital.
• The discussion highlights the risk that higher long-term yields could significantly impact the US housing market via mortgage rates.
• John Authers notes that while earnings multiples have compressed due to high yields, stock prices remain resilient due to rising earnings.

Main topics

• US 10-year Treasury yields
• AI investment and capital demand
• Government debt and sovereign risk

Notable quotes

The whole edifice of finance is built, consciously or otherwise, on this keystone of the 10-year yield.

Conclusion

The episode concludes that while higher yields present significant cha

Transcript preview

Speaker 1 (0:00) AI is entering its most consequential phase where scale, safety and sovereignty will determine who leads and who lags. Join Bloomberg Tech in London on November 2nd and 3rd as global leaders across business, finance and policy examine the defining trade-offs shaping the future of AI. Thank you to our presenting sponsor, Salesforce, and supporting sponsors, IDA Ireland and Schneider Electric. Learn more at BloombergLive.com slash Tech London. Speaker 4 (0:32) Bloomberg Audio Studios. Podcasts. Radio. News. Speaker 7 (0:37) The whole edifice of finance is built, consciously or otherwise, on this keystone of the 10-year yield. Everything else adds on to that. And a lot of structures haven't been tested with a 10-year yield as high as 6%. So this is potentially a big sea change that is still only starting. Speaker 2 (1:04) I'm Stephanie Flanders, head of government and economics at Bloomberg, and this is Trumponomics, the podcast that looks at everything in the economic world of Donald Trump. Speaker 2 (1:15) This week, the US government bond market crossed a line that investors have been watching for years. On Monday, the US 10-year treasury yield, in effect the rate the federal government borrows at, breached 5 % for the first time in several years. And on Tuesday, it went higher to 5.04%, the highest since 2007. And that's up from just 1.3 % five years ago. In living memory, there's never been such a dramatic rise in the interest rate that investors demand to lend to the US government. Now, in case you're wondering why this matters to you, that yield historically sets the tone for pretty much all private lending rates in the US and has a massive influence on the cost of money for all of the world's borrowers, governments, businesses and households. In fact, arguably, it's the single most important price in the world. So there. Well, we're recording Wednesday morning ahead of the Federal Reserve's latest interest rate decision and markets are watching closely for what Kevin Walsh and the Monetary Policy Committee decide about the short-term rate that the Fed controls, the federal funds rate. The overwhelming consensus is that the US central bank will raise that short-term rate today, but it actually doesn't matter for our conversation what happened, because whatever the committee has decided by the time you listen to this, there probably isn't very much the Fed can do about those higher bond yields, because many of the big structural forces that drive the longer-term cost of money are now pointing to higher yields for some time to come. In fact, far from being a ceiling, 5 % may be the new floor for the most important number in global finance. So I want to get into that and also how much higher the cost of borrowing could go from here with John Authors, joining me again from New York, Bloomberg Opinion columnist, author of the Points of Return newsletter. Welcome back, John. Thanks for being here. I know that you're sort of waiting, whip it like, for the Federal Reserve decision as we speak. Speaker 7 (3:22) This is a great way to occupy. These are some of the deadest hours there ever are. I could spend time looking at what markets are doing in the hours before we hear from the Fed, but there's really no point. A lot of traders actually sleep in because, or by their standard, sleep in because they know. the action is going to start at two. We've discovered that you're doing Speaker 2 (3:41) absolutely nothing on a... I was too busy twiddling Speaker 7 (3:44) my thumbs otherwise. So yes, yes. Speaker 2 (3:46) And here in London is again, Jamie Rush, Bloomberg's Director of Global Economics. And in fact, my co-author with the Chief Economist, Tom Orlick, of a book on this subject, The Price of Money. Jamie, thanks for being here. Speaker 6 (3:57) Great to be back. Speaker 2 (4:01) John, we will get into the long-term forces driving this in a minute with you and with Jamie. But if we're just thinking about the run-up we've seen and the sort of discussion around it this year, this big increase in yields, I guess, in effect, investors becoming less keen on holding government debt. Why? Speaker 7 (4:21) Because the world is getting a somewhat more expensive place because de-globalisation is there. is happening and that makes everything more expensive than it used to be. Because the quantum of debt that governments hold is enormous, that doesn't necessarily mean that they're more likely to default, but it does mean if you've got that much more debt that you need to offer, that through the laws of supply and demand, you're going to have to offer a higher rate to get people to lend to you. Speaker 7 (4:52) Other than the Iran war, which is obviously an external shock, but I think the somewhat more endogenous shock that people still hadn't really seen coming is the amount of borrowing being done to fund AI data centers. That's the biggest real new investment in new capital in some decades. I've seen estimates that it's actually going to be a bigger proportion of the US. GDP than the Marshall Plan was of Western Europe's GDP in the years after. To give you an Speaker 2 (5:23) idea Speaker 7 (5:23) of that, it's comparable to what FDR did in the New Deal. That is being done by private sector actors who are mostly possessed of extremely strong credits. Amazon and Google are not quite as strong credits as Uncle Sam, but broadly speaking, you do expect them to pay back. So you've got this big new source of supply, which again, laws of supply and demand, if there is more. debt, looking for people to lend to them, you're going to have to offer more before they will lend to you rather than to somebody else. But in terms of what we couldn't absolutely see coming 12 months ago that has happened, those are the main things. Speaker 2 (6:03) We are talking on the day of the Fed decision. Without getting into the impact of this particular decision, there is an expectation, whether it's two or three, or maybe Kevin Walsh is hoping one, but there's a pretty strong expectation we're going to be in a tightening cycle over the next few months, possibly a year, depending on how things go. Normally, and you've been looking at the way markets react to these things for many years, what does that mean for yields? Speaker 7 (6:29) There are important differences between overnight rates. and 10-year yields, which I don't think we want to get fully into the thickets of why that is. But yes, there will be a connection when the Fed is in a tightening cycle. Generally, that does mean that 10-year yields will also rise. I cited some research by Jim Reid of Deutsche Bank, who's a very good financial historian. In round numbers, you'd expect a tightening cycle to last. For 75 basis points or percentage point, that's what the markets expect. Broadly speaking, the base