It's a ripe summer in the American economy, and the AC thermostat hangs in the hottest room in the house, the kitchen, where the sun streams in and the oven is always set to broil.
The thermostat in this case is the bond market, working to offset the blistering demand for debt from governments and companies by raising borrowing costs to multiyear highs. The kitchen is the AI-buildout sector, desperate to turn some $2 trillion into vast reserves of computing capacity by the end of next year.
The lift in bond yields isn't having much effect in moderating the pace of capital-raising and corporate investment. But it could threaten to overcool other parts of the economy, such as housing and Main Street spending.
This is the backdrop in which Treasury Secretary Scott Bessent sought to restrain longer-term Treasury yields last week by expanding an existing program to buy back small amounts of less-liquid government debt in the open market.
The move prompted a rather overheated response from market participants and commentators, as either a bad look for a Treasury Secretary who had charged his predecessor with untoward massaging of market rates, or too small to matter, or both. The criticism intensified after the initial drop in yields reversed a day later, while sharp declines in the U.S. dollar and jump in gold prices held, a combination that could be read as a vote of no confidence in the stewards of the financial-policy apparatus.
And, of course, the selloff in bonds inevitably inflames worry over a long-threatened fiscal breakpoint becoming reality. Unease over the U.S.'s ability to finance structural deficits is like an autoimmune condition: It flares up under the stress from adverse market stimuli, such as overheating capex and war-inflation feedback loops, then often goes dormant again.
But would it come as a surprise to learn that the 10-year Treasury yield's rise last week amounted to a mere 4 basis points, to 4.74%? That the yield has been up here before a couple times over the past three years, if only briefly? What about the fact that the yield on investment-grade corporate debt remains below its peak from a few years ago, because spreads over Treasuries are so snug?
The absolute yield level isn't broadly punitive yet to big companies. Nor, for now, is it a strong undertow pulling down equity values. With nominal GDP growth (real growth plus inflation) running near 5-6% right now, how much lower would one expect 10-year yields to be? The steepness of the yield curve is likewise not extreme relative to historical ranges.
The orderliness of the move so far has allowed the stock market to hang relatively tough for now. There are no clear trigger thresholds for yields that instantly undercut equities, even if equity investors are watching warily.
The textbooks say the cycle high in real yields – the 30-year real yield, or nominal yield minus market-projected inflation, now exceeds 3% – should act as a restraint on economic growth and equity valuations. Such effects can be subtle, long-gestating and offset for a time by exciting corporate growth in the here and now.
It's also important to recognize that the S&P 500 has lived pretty comfortably in that same sweltering kitchen with the AI builders. About a third of its recent earnings growth is directly from AI infrastructure companies. It truly is a capital-goods and business-to-business benchmark more than a gauge of broad U.S. consumption. The consumer-discretionary sector makes up 9.2% of the S&P, but its weight drops below 4% if AI/tech proxies Amazon and Tesla are excluded.
Thus, the market hovers within a couple of percent of record highs, even as last week showed July housing starts fell 12.4% and Walmart posted its weakest quarterly comparable-store sales growth since 2020.
This isn't to suggest the underlying economy is struggling broadly; not at all. Consumer-spending growth oscillates in a stable range, unemployment is low, the aggregate consumer debt-service burden manageable.
Yet wage growth is sagging while inflation remains elevated, tax-refund windfalls are in the past and the real juice in the economy remains corporate spending fueled by ample earnings – a capital-over-labor dynamic that makes rising interest rates play to the public as an exacerbating factor on "affordability" rather than a positive sign of household-sector momentum.
For investors, the same fattening of real yields embedded in Treasuries that raises the hurdle rate for borrowers represents compensation paid to the owners of the debt. Is value therefore building in bonds, just as conventional wisdom turns against their role as a diversifier for equities?
