In the shadow of the AI revolution: The truth behind US bond yields

According to the economic review conducted by Afonso Borges, a researcher at Julius Baer bank, corporate issuances related to AI have grown and carry significant duration, but evidence suggests they did not play a central role in the rise in yields of long-term US government bonds.

"Instead, we believe that the declines are better explained by higher expected policy rates and renewed uncertainty regarding the Fed's reaction function to inflation, while swap spreads, auction demand, and curve pricing show only few signs of broad distortion driven by supply," the expert noted.

According to him, the supply of corporate bonds is on an upward trend, accounting for 22.7% of US bond issuances year-to-date, compared to an average of 18.9% over the last decade, based on the latest data from the Securities Industry and Financial Markets Association.

As is well understood, the AI capital expenditure cycle is behind this increase. Additionally, we note that AI-related issuances carry a longer duration than aggregate data suggests, given the long duration used to finance data center infrastructure. Accordingly, it is reasonable to ask whether these flows add pressure to government bond yields, especially at the long end. Overall, the evidence so far suggests that the impact has been secondary.

1. 30-year US government bonds have become 10 basis points more expensive against swaps over the past year. Undoubtedly, swap spreads are not a perfect measure, as they also reflect the supply of government bonds, repo conditions, and dealer balance sheet constraints.

2. Our fair value model for 10-year US government bonds attributes about 90% of the 70 basis point decline since the start of the war in Iran to the 110 basis point rise in the 1y1y OIS, the variable we use to measure monetary policy expectations.

3. The 10-year ACM term premium is only slightly above its one-year average, and a significant portion of its recent rise occurred after Kevin Warsh's second press conference, when questions regarding the Fed Chair's reaction function and the inflation framework weighed on the long end.

4. Auction results indicate that Treasury supply has generally been well absorbed in recent months. "Our primary demand index combines participation from end-users and 'tails' in auctions throughout government bond auctions, weighting each auction by its size and duration."

5. It shows that supply has been absorbed relatively well in recent months, in contrast to late 2023, when weak auction results and low demand from end-users fueled concerns regarding the volume of issuances. Curve pricing at the long end also appears generally consistent with the level of interest rates at the front end: the 10-year/30-year curve is only about 5 basis points steeper than our model estimate, compared to a deviation of more than 15 basis points around the liberation day.