At High Enough Interest Rates, Everyone Starts to Care
Key Takeaways
- Long-term rates are demanding attention. The 30-year Treasury yield reached a post-GFC high above 5.3%, with potential implications for business investment, consumer confidence and asset values.
- Several forces are keeping pressure on yields. Inflation concerns, rising government debt and deficits, significant AI-related spending, and shifting foreign demand for U.S. Treasuries are contributing to higher long-term rates.
- Duration remains an important consideration. Given uncertainty around rates and potential policy intervention, ACM continues to favor 3–7-year bonds while maintaining limited exposure to more interest-rate-sensitive long-dated bonds.
Rising interest rates are dominating the headlines and, many would argue, for good reason. The 30-year Treasury yield hit a post-GFC (Global Financial Crisis) high this week touching just above 5.3%. Long-term interest rates (15+ years) appear to have caught the attention of the stock market, bond market, and even the Treasury Department. However, the overall stock market remains near all-time highs given enormous AI optimism, a relatively strong economy and record profits in the most recent quarter. In an unusual action, the Treasury Department announced Wednesday, August 19th, that the Treasury would be “increasing, by at least double” its purchases of 10-year to 30-year Treasury bonds. While the buyback operations are only doubling from $2bn to $4bn , we take the view that the signal is significantly more important than the magnitude. The Treasury does not want long-term interest rates to rise uncontrollably due to the broader implications on the economy. Long-term rates deemed “too high” could negatively impact consumer and business confidence, corporate investment, and asset values to name just a few of the broad reaching implications. And, yet, that attempt to lower rates appears to have failed, as long-term rates almost completely reversed course the very next day.
Why Long-Term Interest Rates Are Getting the Market’s Attention
Post the GFC (2009-2019), inflation was relatively moderate for more than a decade until Covid. Since Covid, inflation pressures have been building, first due to massive government stimulus and the re-opening of the economy, and now oil & broad price inflation due to the Iran conflict as well as massive AI hyperscaler spending. The magnitude of hyperscaler spending is in the trillions. Not only are companies spending most or all of their cash flow, some are also issuing equity and debt, which gets reflected on their balance sheets. Additionally, many are also agreeing to substantial future financial commitments in the form of leases and purchase commitments. The resulting inflation concerns combined with increasing government deficits, and now a ~$40 trillion government debt burden, have led to a nearly 20-year high in the long-dated Treasury yields. While the government debt as a percentage of GDP has been stable/slowly increasing around 120% of GDP for the past five years, the level of debt has increased by more than 50%. Notably, at around 120% Debt-to-GDP, government debt is approximately double pre-GFC levels and approximately 20% higher than pre-Covid levels. Funding a growing deficit requires continuously finding incremental buyers; however, foreign holdings as a percentage of total U.S. debt has been declining, so foreign buyers have not sufficiently increased their purchases. Part of the decline in foreign demand reflects higher yields on foreign government bonds, which has increased their relative attractiveness. One prominent driver of higher foreign government bond yields is the increasing global spending on defense budgets. Notably, a meaningful portion of foreign holders, “foreign official institutions,” have actually decreased gross dollar holdings of U.S. debt.
What’s Driving Long-Term Treasury Yields Higher?
The Treasury is well aware of all this and on Wednesday, August 19th, the Treasury Secretary, Scott Bessent, decided to signal the Treasury was watching long-end rates carefully. While the Treasury action is a relatively minor dollar amount, the signal was meaningful. Bessent was a successful investor before he became Treasury Secretary so he likely appreciates the importance of signaling.
Why Higher Interest Rates Matter for the Economy and Markets
Additionally, business investment could slow meaningfully as a higher cost of capital makes the potential return on new projects less compelling. Consumer confidence could also take a hit as long-term rates adversely affect housing sentiment, buying activity, and prices. A higher 30-year Treasury also negatively impacts asset values, including those in the stock market and in bond prices. While the Treasury obviously wants to avoid the negative ramifications of higher rates, resolving the Iran conflict and reducing the government deficits are difficult tasks.
What Higher Rates Could Mean for Bond Investors
While we don’t foresee government deficits ending anytime soon, the Treasury just made it hard to bet that long-term yields are going to rise uncontrollably. Even so, we think making a substantial bet on 30-year yields is not prudent currently. The quick reversal in yields last week doesn’t alter the wisdom of that bet given potential future interventions (such as the Fed shrinking its balance sheet). While there are always select securities that are compelling, in general we suggest caution in regards to long-dated securities that are more interest rate sensitive. Instead, we still prefer to focus on 3–7-year bonds with limited exposure to long-dated bonds. The next Fed meeting is September 16, 2026, and we expect Kevin Warsh to focus on the importance and urgency of the Fed reducing inflation closer to 2%. While the market is currently assuming no change to the Fed Funds rate in September, the Fed will likely discuss potential future actions. And we will get to see if Chairman Warsh tips his hand with his Jackson Hole speech on Friday.