What’s Really Driving Treasury Yields?

Key Points

• • 10-year Treasury yields climbed to 5.3% in early October, up from below 4.0% in late February.
  • Central banks are hiking rates and lifting the yield curve.
  • QT by the ECB and Bank of Japan is increasing supply in bond markets.
  • A debt maturity wall and capital expenditure on AI data centers are increasing private debt issuance.

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We all know what triggered the initial surge in long-term Treasury yields. The 10-year was trading below 4.0% on February 27 but jumped sharply after the US and Israel bombed Iran that weekend.

The new Fed Chair Kevin Warsh’s keynote speech at Jackson Hole on August 28 added further impetus. Warsh’s hawkish tone, though short on specifics, led the bond market to conclude that rate hikes were coming, with the 2-year Treasury yield jumping by nearly 70 basis points in the next 4 weeks.

Persistent inflation has given central banks little choice. Many are hiking rates, including the Fed, the ECB, the Bank of Japan, and even Australia’s RBA. One notable exception is the People’s Bank of China.

Does this mean that rates will soften if oil prices fall? If the conflict in the Persian Gulf were settled and oil flows returned to normal, oil prices would likely settle after inventories are restored, but are unlikely to return to pre-war levels. However, we attach a higher probability to a protracted war that could drag on for years, with oil prices remaining elevated.

In either case, we are unlikely to see another bout of QE, which drove the 10-year yield below 4.0% for more than a decade.

Central banks are still repairing their balance sheets (QT) after the last expansion, which will likely keep upward pressure on long-term yields for several years. The Bank of Japan (BOJ) has shed $3 trillion of securities since its pandemic peak, while the Fed shed $2.4 trillion under Jerome Powell before resuming purchases in December last year.

The European Central Bank (ECB) has gone even further, shedding $4.3 trillion or 53% of its QE assets (blue line below) since mid-2022. The green total assets figure is distorted because the ECB revalues its Gold reserves to market prices at the end of each quarter.

Both the ECB and BOJ are steadily reducing the securities on their balance sheets, increasing supply in bond markets and adding upward pressure on yields. The Fed under Warsh will likely resume its gradual downward path.

A notable exception is the PBOC, which has steadily expanded its balance sheet, adding close to $2 trillion since 2020. This highlights the extent of China’s economic problems. Despite a record trade surplus of $1.2 trillion, the PBOC continues to debase the currency to soften the impact of the domestic contraction.

Debt Maturity Wall

Adding fuel to the increased supply from central bank QT (apart from the PBOC) is the wall of private-sector bond maturities that will need to be rolled over in the next few years.

Many corporations took advantage of record-low interest rates in the early 2020s to refinance at lower rates. That debt is now maturing and will need to be rolled over at much higher rates.

AI Financing

Hyperscalers need to spend $9.6 trillion between 2025 and 2032 to build 183 GW of data center capacity, according to estimates by Stijn Van Nieuwerburgh. Morgan Stanley estimates that more than half of the roughly $2.9 trillion required to meet hyperscalers’ incremental compute needs over 2025–2028 will come from outside capital (Morgan Stanley Research, 2025).

Falling Private Demand

“The cure for high prices is high prices.”

The abuse of the large captive investment market for government bonds, suppressing yields to artificial lows through QE, has reduced demand for traditional insurance annuities and pensions. Insurers and pension funds have adapted by increasing exposure to private debt, infrastructure, and alternative investments while reducing allocations to government bonds.

The chart below highlights the decline in France’s government bonds (OATS) held by domestic insurers and pension funds (green below), from about 25% in 2014 to less than 11%.

Conclusion

Central bank QE has reduced investment demand for government bonds from traditional investors, such as insurers and pension funds, due to artificially low yields. The US Treasury is increasingly reliant on hedge funds to fund new issuance through highly leveraged repo-market trades.

A number of central banks are now shedding QE assets, increasing supply in bond markets. At the same time, many developed economies run large deficits, increasing government debt issuance. Capital expenditure on data centers and a large debt maturity wall have also increased private debt issuance.

Many central banks are hiking interest rates to curb inflation. It is unclear how long the war in the Persian Gulf and related oil shortages will last, adding to inflationary pressures.

Rising bond yields increase the cost of servicing government debt and drive up deficits, pushing bond markets towards a crisis.

The imbalance between debt supply and demand in bond markets is expected to maintain upward pressure on long-term yields. However, two factors could change this: a steep decline in government deficits, financed through spending cuts or tax hikes, or more central bank QE. Both seem unlikely, but desperate times may call for desperate measures.

Acknowledgments

• CoinDesk: Bitcoin
• Federal Reserve of St. Louis: FRED Data
• CNBC: 2-Year Treasury Yield
• Hanno Lustig: Le Boomer Spread
• Michael Howell, Cross Border Capital: Debt Maturity Wall
• Stijn Van Nieuwerburgh, Columbia Business School: Financing the AI buildout
• Hanno Lustig: Nine Percent of GDP
• CBO: The Budget and Economic Outlook, 2026 to 2036
• Yardeni Research: Central Bank Charts
• Wolf Richter: Still QT plus Renewed Rate Hikes at the ECB despite Surging Bond Yields in the Euro Area
• Robin Brooks: The New Treasury-Fed Accord Takes Shape