Long-term interest rates have climbed to levels not seen in decades, and the move is creating important implications for investors. While much of the recent focus has been on Federal Reserve policy, other forces are putting upward pressure on Treasury yields and influencing borrowing costs, corporate investment, and portfolio strategy.
One of the biggest drivers is increased competition for capital. Major technology companies continue to invest heavily in artificial intelligence infrastructure, financing much of that spending through the bond market. Investment-grade bond issuance has risen sharply this year, with AI-related companies accounting for a significant share of new debt. As both corporations and the U.S. Treasury compete for investor capital, a larger supply of bonds requires higher yields to attract buyers.
Government borrowing is also contributing to the trend. The federal government continues to run annual deficits exceeding $2 trillion, resulting in additional Treasury issuance that investors must absorb. At the same time, rising interest rates outside the United States are changing the global investment landscape. Countries such as Japan are now offering more attractive yields on their own government debt, reducing the incentive for some international investors to purchase U.S. Treasuries.
Together, these factors have pushed longer-term Treasury yields substantially higher. The 10-year Treasury yield remains around 4.7%, while 30-year Treasury yields have reached levels not seen in decades. Those higher yields ripple throughout the economy, increasing borrowing costs for both consumers and businesses. Mortgage rates have climbed to their highest level in roughly a year, while companies relying on debt to fund large capital investments face a higher cost of financing.
Higher yields also affect investment decisions. As bond yields become more attractive, they begin competing more directly with stocks for investor capital. While equities continue to offer long-term growth potential, today's fixed income market provides income opportunities that were largely absent for much of the past decade. Investors no longer have to choose between pursuing growth and generating meaningful income.
Although no one knows exactly where long-term interest rates will go from here, today's environment reinforces the importance of diversification. Maintaining exposure to both stocks and bonds allows investors to participate in long-term equity growth while taking advantage of improved yields in fixed income, helping build portfolios that are better positioned for a range of market conditions.
Often quoted in major national media, Adam is a Chartered Financial Analyst (CFA®), a CERTIFIED FINANCIAL PLANNER™ (CFP®), and has been included on the Forbes NextGen Best-in-State Wealth Advisors 2019 list. He is a member of the CFA Society of Los Angeles and the CFA Institute. Adam helps establish asset allocation strategy as a member of the EP Wealth Investment Committee, which supports all EP Wealth Advisors and their clients. The Committee’s top-down approach to portfolio construction begins with an outlook on the economy’s likely direction, followed by the implications for different economic sectors and asset classes. This culminates in strategic selection of the individual stocks, bonds, mutual funds or other investments deemed most appropriate for each individual client’s portfolio.
EP Wealth Advisors offers a comprehensive range of services to help you invest with greater insight, as well as develop a holistic wealth management strategy. To discuss your finances and investment goals, we invite you to contact one of our advisors.
Disclosures:
Video Transcript:
Adam Phillips:
Fair warning: this week’s update is going to be a little wonkier than usual. But stick with me, because what’s happening in the bond market right now has some pretty important implications for investors.
This week, I want to spend a few minutes talking about something that’s been getting a lot more attention lately, and that’s the move higher in longer-term interest rates.
The 10-year Treasury yield is around 4.7%, and yields on the 30-year have moved to levels we haven’t seen in decades. In fact, last week the Treasury sold $25 billion of 30-year bonds at a yield of 5.216%—the highest yield for that type of auction since 2021.
So, what’s driving this?
I think there are really three things worth paying attention to.
The first is simply a lot more competition for capital.
We’ve talked quite a bit about the massive amount of spending taking place around artificial intelligence. The biggest technology companies are spending enormous amounts of money building data centers and the infrastructure necessary to support AI.
And increasingly, they’re tapping the bond market to help fund that buildout.
Investment-grade companies have issued nearly $1.5 trillion of bonds this year, which is up about 36% from a year ago. Roughly 20% of that issuance has come from AI-related companies. And when you look at the biggest technology companies specifically, their borrowing is equivalent to roughly 25% of the Treasury’s net issuance to private investors.
That’s a pretty remarkable number.
And the scale of that spending is pretty remarkable. Capital expenditures at Amazon, Meta, Microsoft and Alphabet have accelerated dramatically, and are expected to continue climbing, while their free cash flow hasn’t kept pace. That helps explain why these companies are increasingly turning to the debt markets to finance some of that investment.
And there’s only so much money to go around.
If the Treasury needs to borrow enormous amounts of money, and at the same time some of the largest companies in the world are also issuing enormous amounts of debt, somebody has to buy all of those bonds.
More supply, without a commensurate increase in demand, generally means investors are going to demand a higher yield.
The second issue is our fiscal situation here in the United States.
The federal government continues to run annual deficits in excess of $2 trillion.
That means more borrowing, more Treasury issuance and, again, more supply that investors have to absorb.
And then the third piece is something we probably don’t talk about as much, which is what’s happening with interest rates outside the United States.
For a long time, U.S. Treasuries were one of the few places around the world where investors could earn much of anything on high-quality government debt.
Think back to 2020. At one point, there was more than $18 trillion of negative-yielding debt around the world.
And negative yielding literally meant investors were effectively paying governments for the privilege of lending them money.
That environment is gone.
Today, yields are rising in a number of major economies as they deal with their own inflation and fiscal challenges. Japan is particularly important. Japanese government bonds are now yielding more than they have in roughly 30 years.
And Japan matters here because they’ve historically been a very reliable buyer of U.S. Treasuries. In fact, Japan is the largest foreign holder of Treasuries, with more than $1.1 trillion. So if Japanese investors can suddenly earn more attractive yields at home, that potentially reduces an important source of demand for U.S. government debt.
That matters because global investors now have alternatives.
If you’re a Japanese investor, for example, you no longer necessarily have to come to the United States and take currency risk just to earn a reasonable yield.
So you put all three of those things together—massive corporate borrowing related to AI, continued U.S. government deficits, and increasingly attractive yields overseas—and you can understand why there’s upward pressure on longer-term Treasury yields. And when you take a longer-term view, the change is pretty dramatic. Both the 10-year and 30-year Treasury yields have moved substantially higher from the extraordinarily low levels we saw around 2020.
So what does all of this mean for investors?
There are a few implications.
The most immediate is higher borrowing costs. The average 30-year mortgage rate has moved up to about 6.7%, its highest level in a year.
Higher yields also raise the cost of capital for corporations—particularly companies making large capital investments and relying on debt rather than free cash flow to finance them.
And then there’s one other implication that I think becomes increasingly important if yields remain elevated.
At some point, bonds start becoming real competition for stocks.
If investors can lock in yields of 5%, 6%, or potentially more in certain parts of the bond market, while taking a fraction of the volatility they would experience in equities, that becomes a pretty compelling alternative.
I don’t think we’re necessarily at the point where that causes investors to abandon stocks. But the higher yields go, the higher the hurdle becomes for equities.
And I think that reinforces something we talk about all the time: the importance of diversification.
For much of the last decade, bonds offered very little income. Today, investors have more options. And having meaningful exposure to both stocks and bonds gives us the ability to participate in long-term equity growth while also taking advantage of much more attractive yields in fixed income.
That’s something we’ll continue to watch closely, particularly if longer-term rates continue moving higher.
Have a great week, everyone.
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