Despite expectations that the US Federal Reserve will freeze its benchmark interest rate, US long-term treasury yields are continuing their high-flying march. This upward pressure is driven by a combination of massive national debt and surging demand for artificial intelligence (AI) investment capital. The ‘term premium’—an additional compensation for holding long-term government bonds—has surged to its highest level in 12 years. It is a ‘paradox of interest rates’ where the cost of borrowing money in the market rises even without the Fed rushing into additional rate hikes.
According to foreign media including the Wall Street Journal (WSJ) on the 9th (local time), the US 10-year Treasury yield recorded 5.243%. After briefly spiking to 5.364% during intraday trading on the 7th to hit a 24-year high not seen since 2002, it has pulled back slightly. The 30-year yield also hovered in the 5.6% range. While strong demand during the Treasury auction helped calm the sharp surge, yields remain at elevated levels.
Surge in Term Premium and US Fiscal Burdens
What stands out most is the sharp spike in the term premium. According to estimation models by the Federal Reserve Bank of New York, the term premium on the US 10-year Treasury recently approached 1 percentage point (100bp, where 1bp = 0.01%), rising to its highest level in 12 years. It has jumped about 40bp over a two-week period.
The term premium represents the extra return investors demand for bearing uncertainties such as inflation or interest rate fluctuations while holding long-term government debt. US Treasury yields are typically determined by expectations for future short-term rates and the term premium. For example, if the average expected short-term rate is 4% and the term premium is 1 percentage point, the 10-year Treasury yield comes out to roughly 5%. Even if expectations for a Fed rate freeze grow, long-term yields can still rise if investors demand higher compensation.
Behind the rise in the term premium lies the burden of US fiscal policy. Large-scale government bond issuance continues as national debt surpasses 40 trillion dollars. Meanwhile, inflation uncertainty has also grown due to rising international oil prices stemming from the war involving Iran. Notably, the yield spread between US 10-year and 30-year Treasuries widened to about 37bp this week, reflecting a market move demanding higher returns on longer-dated debt.
Alex Morris, co-founder of F/m Investments, told Reuters on the 9th that investors favor 10-year bonds over 30-year bonds because they perceive a greater likelihood of trouble in the long-term fiscal situation of the United States. He noted that this effectively questions whether the US Treasury is properly managing its finances.
AI Investments and Ripple Effects on the Real Economy
AI investments are another factor pushing up long-term yields. As Big Tech companies expand corporate bond issuances to build data centers and power grids, governments and the private sector are competing for investment funds. This has even led to a phenomenon where corporate bond investors sell Treasury futures to mitigate interest rate fluctuation risks.
The minutes of the September Federal Open Market Committee (FOMC) meeting released on the 7th also highlighted market assessments that large-scale private bond issuances for AI infrastructure investments have influenced the rise in Treasury yields and term premiums. While the majority of participants deemed further hikes within the year appropriate, they did not specifically signal an immediate need for a hike in October. According to the CME FedWatch tool, the probability of an October freeze stood at about 82% as of the 9th.
When the term premium rises, loan rates for households and businesses also increase, placing a burden on the real economy. The US 10-year Treasury yield influences mortgage rates and corporate long-term funding costs. According to Mortgage Bankers Association (MBA) statistics, last week’s 30-year fixed mortgage rate hit 7.49%, the highest level since November 2023, while mortgage applications fell 4.2% from the previous week.
Businesses may see investments contract due to rising borrowing costs, and the government must also roll over maturing bonds at higher rates. Increased interest burdens can lead to expanding fiscal deficits, raising the possibility of a vicious cycle of rising yields driven by additional bond issuances. Sustained high US long-term yields could also put pressure on South Korean treasury bond yields and the won-dollar exchange rate. Nevertheless, higher yields have also stimulated bond buying appetite, with the US 10-year Treasury auction on the 7th recording a bid-to-cover ratio of 2.77 times, and the 30-year auction on the 8th showing solid demand at 2.54 times.
