The artificial intelligence boom is fueling a surge in capital demand that is pushing long-term borrowing costs to 17-year highs, leading futures traders to price in the rising possibility of a Federal Reserve interest rate hike before the end of the year.
"Rising productivity, combined with large capital expenditure needs, points to a higher neutral real interest rate," Barclays' Christian Keller and Akash Utsav wrote in the firm's annual Equity-Gilt Study.
The conflict between AI-driven growth and monetary policy tightening sent the 30-year Treasury yield (^TYX) to 5.2% for the first time since July 2007, while the benchmark 10-year yield (^TNX) climbed to 4.68%. The pressure on rates contributed to a risk-off tone in equities, with the tech-heavy Nasdaq Composite falling 0.8% in recent trading.
The market repricing presents a challenge for the Fed, which has held its policy rate at a 23-year high of 5.25-5.50% since July 2023. While policymakers believe policy is restrictive, a wave of AI-related bond issuance to fund an estimated $7.6 trillion in spending could sustain inflationary pressures, forcing a hawkish pivot that markets had not anticipated just months ago.
The New Inflationary Engine
A growing consensus among investment firms is that the sheer scale of AI-related capital expenditure is creating a structural shift in the relationship between savings and investment. Goldman Sachs estimates that AI infrastructure spending could reach $7.6 trillion over the next five years. This immense demand for capital, evident in a surge of AI-related convertible bond sales, is directly competing with government borrowing and pushing yields higher.
"Markets should not assume a return to the very low real-rate world of the 2010s based on the ongoing AI boom," the Institute of International Finance said in a recent report, arguing that higher expected returns will lift investment relative to savings.
This new dynamic helps explain why both AI-centric stock indexes and long-term bond yields have been rising in parallel, a phenomenon that has puzzled some investors. The investment boom is further complicated by rising energy prices, spurred by blockades in the Strait of Hormuz, which have lifted Brent crude futures to near $111 a barrel and added to immediate inflation concerns.
Labor's Declining Share
A key variable in the long-term outlook is how AI's productivity gains are distributed. Economists are split on whether AI will augment existing jobs or replace them, a question with significant implications for the labor share of GDP, which has been in a long-term decline.
TS Lombard economist Dario Perkins argued that the wage share of income is closely correlated with R-star, the neutral interest rate. He contends that for bond yields to remain structurally higher, the wage share must recover. "Either the wage share must recover, or all this talk about a new regime of structurally higher bond yields is probably wrong," he wrote.
However, analysis from Barclays suggests that the combination of AI and humanoid robotics will widen the range of jobs susceptible to automation, putting further downward pressure on labor's share of income. This could weigh on aggregate demand, acting as a potential brake on runaway yields. Yet, the Barclays economists believe a more immediate inflationary impulse will come from the massive electricity and commodity requirements of the AI build-out, stoking inflation through raw materials rather than wages.
For now, investors are betting the boom has room to run, with just 4% of global asset managers in a recent Bank of America poll expecting a "hard landing" for the economy. More than 60% of those polled expect the 30-year Treasury yield to exceed 6% within a year, suggesting bond markets are bracing for a world where AI is an inflationary, not deflationary, force.
This article is for informational purposes only and does not constitute investment advice.
