PIMCO Believes Fed Expectations Main Driver of Treasury Yields Over AI Impact

Treasury Yields Rise as Analysts Debate AI's Impact on Bond Markets

A boom in artificial intelligence-related borrowing may have significant implications for bond markets in the long term, according to Pacific Investment Management Co. However, the recent rise in long-dated Treasury yields is not being driven by the debt-funded AI investment, but rather by shifting expectations for the Federal Reserve's interest-rate path in response to the Iran war, which has increased inflation risks.

Pimco multi-asset credit strategist Lotfi Karoui wrote in a report that while structural pressures from the AI buildout are real, they are growing slowly and are not the primary driver of the current yield moves. Instead, cyclical factors continue to support the hedging role of bonds. Treasuries have sold off in recent weeks as investors increasingly bet that the Fed may need to keep rates higher for longer after the Iran war spurred the biggest inflation surge since 2023.

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The surge in long-term borrowing costs has raised questions about the ability of markets to absorb additional borrowing, particularly from tech companies. These companies have sold more than $300 billion of bonds to US investors, prompting debate over the long-term implications for sovereign debt markets. The yields on benchmark 10-year Treasuries have risen more than 50 basis points from this year's low, while those on 30-year Treasuries have climbed more than 30 basis points.

Traders have pivoted from pricing rate cuts before the war to a more than 60% chance of a Fed rate hike by December. Karoui notes that the "duration supply shock" from AI borrowing has yet to fully arrive, and points to measures such as the Bloomberg US Corporate Investment Grade index, where duration remains well below post-Covid highs. This suggests that the market has not had to absorb the full amount of longer-dated bonds that a sustained capex cycle could eventually generate.

Despite concerns about the impact of AI-related credit expansion, wider fiscal deficits, and persistent external imbalances, Karoui argues that US Treasuries have not lost their hedging role in multi-asset portfolios. Cyclical market behavior should be distinguished from longer-run concerns, and the current rise in Treasury yields is better explained by shifting expectations for the Fed's interest-rate path rather than the debt-funded AI investment.