Yields in a crucial part of the Treasury market keep falling — and it may have something to do with AI
A quiet but consequential shift has been unfolding in the U.S. Treasury market: key long‑dated yields, especially inflation‑adjusted (real) yields and the term premium embedded in 10‑ and 30‑year notes, have been trending lower. That’s counterintuitive in a world still wrestling with sizable fiscal deficits and heavy Treasury issuance, both of which ordinarily push long rates up. While softer inflation prints and shifting Federal Reserve expectations are the obvious explanations, there is a less appreciated force likely at work too: artificial intelligence.
AI’s impact on markets is most visible in equities, where mega‑cap tech names and chipmakers have driven indexes higher. But the same forces lifting stocks can spill into bonds through expectations, portfolio rebalancing, and hedging flows. Together, they can compress long‑term real yields and the extra compensation investors demand for holding duration risk — a “crucial part” of the curve that influences everything from mortgage rates and corporate borrowing costs to government interest expenses and discounted cash‑flow valuations.
Which yields are falling — and why that slice matters
– Real yields: These are the yields on Treasury Inflation‑Protected Securities (TIPS), and they set the baseline discount rate for future real cash flows. When 10‑year real yields fall, the present value of long‑duration assets rises, and so do incentives for long‑horizon investment.
– The term premium: This is the compensation investors require to hold long‑maturity Treasuries instead of rolling over short bills. It tends to rise with uncertainty and inflation risk, and fall when macro risks are perceived to be better anchored. A lower term premium pulls down nominal long‑end yields even if the expected path of short rates is unchanged.
Both have drifted lower from their post‑pandemic peaks, despite large net supply. That suggests strong demand for long duration and/or reduced macro and inflation risk premia. AI may be part of the explanation.
Three channels linking AI to lower long‑term yields
1) Expectations channel: productivity, inflation risk, and the premium for uncertainty
– The AI narrative is fundamentally about higher productivity. If investors believe AI will expand supply capacity, raise efficiency, and temper unit labor cost pressures, they will also mark down the odds of stubborn inflation. Lower perceived inflation persistence compresses the inflation risk premium embedded in long bonds and, with it, the term premium.
– Better productivity can make growth less inflationary for any given level of demand. Markets may conclude the Fed won’t need to keep policy as restrictive for as long, pulling forward the pivot in rate expectations and nudging down the real yield curve.
– AI optimism can also reduce macro uncertainty. When investors have more confidence in long‑run growth and price stability, they demand less compensation for duration risk.
2) Portfolio and flow channel: equity gains beget bond buying
– Pension rebalancing and LDI: The equity rally led by AI beneficiaries has improved pension funded status. Historically, when plans become better funded, they lock in gains by increasing their liability‑hedging portfolios — buying long‑duration Treasuries and investment‑grade bonds. That steady demand at the back end of the curve pushes long yields lower relative to the front.
– Risk parity and CTAs: Trend‑following and multi‑asset strategies often add duration when equity volatility falls and stock prices trend higher. The AI‑driven equity melt‑up can thus mechanically pull more buyers into Treasuries, compressing yields without any change in macro data.
– Corporate treasuries and cash piles: Big tech firms with vast cash balances typically park liquidity in T‑bills and short Treasuries. As AI spending plans expand, so do precautionary cash buffers, and the near‑risk‑free asset of choice is U.S. government paper. Heavy demand at the front end can pull bill yields down, while freeing up other investors to extend into longer maturities.
3) Financing and hedging channel: how AI capex ripples into rates markets
– Debt and swaps: Even when AI capex is largely funded by cash flow and equity, related corporate financing often involves issuing fixed‑rate debt and swapping exposures. Dealers and issuers who receive fixed in swaps put downward pressure on swap rates. That, in turn, can pull Treasury yields lower via relative‑value trades and hedging.
– M&A and structured equity: AI has spurred dealmaking, convertibles, and buybacks. The associated derivatives hedging frequently uses interest rate instruments, adding to receiving flows in rates and steady demand for duration from dealers and asset managers.
– Volatility and convexity: If AI‑led growth optimism coincides with calmer rate volatility, mortgage investors and insurers can increase long‑duration holdings with less concern about hedging costs, further suppressing the term premium.
Why this matters beyond bond desks
– Mortgages and corporate borrowing: Lower long‑end yields reduce fixed mortgage rates and investment‑grade borrowing costs, potentially supporting housing and corporate investment even if short‑term policy stays restrictive.
– Government finance: A compressed term premium lowers the Treasury’s average borrowing cost despite heavy issuance, easing near‑term fiscal pressure.
– Valuations and capital allocation: Lower real discount rates magnify the present value of long‑dated cash flows, reinforcing equity valuations in sectors with distant payoffs — notably tech — and lowering hurdle rates for long‑gestation projects, including AI infrastructure.
Important caveats
– AI could push rates up too: A true capex super‑cycle for data centers, power infrastructure, and semiconductors increases the demand for funds. If investment outstrips private saving, the equilibrium real rate (r*) could rise over time, lifting real yields.
– Energy and capacity constraints: If AI accelerates electricity demand faster than supply can adjust, power prices and capex costs could boost inflation risk premia rather than suppress them.
– Policy and supply effects: Large fiscal deficits and rising term issuance remain powerful forces. If supply overwhelms private demand, long yields can back up even in an AI‑optimistic world.
– Narrative risk: Markets can swing from pricing an AI‑led disinflationary boom to fearing bubbles or execution risk. That would widen risk premia and lift term premium quickly.
What to watch to gauge whether AI is tugging yields lower
– Real yields vs. breakevens: A decline led by real yields alongside stable or slightly firmer breakevens suggests improving growth/inflation trade‑off consistent with productivity gains.
– Term premium estimates: Popular models (such as ACM) trending down alongside calmer rate volatility would be consistent with reduced uncertainty and inflation risk.
– Pension funded status and LDI flows: Improved funding ratios and reported increases in duration hedging typically precede persistent long‑end demand.
– Swap spreads and dealer positioning: Receiving in swaps, tighter swap spreads, and relative‑value demand for Treasuries point to hedging channels at work.
– Bill yields vs. policy rates: Persistent richness of T‑bills relative to administered rates can signal intense front‑end demand from corporate treasuries and money funds linked to large cash pools.
The bottom line
Falling long‑term Treasury yields are not just a story about cooling inflation or an imminent Fed pivot. They also reflect changing beliefs about the economy’s long‑run shape and a web of portfolio and hedging flows set in motion by the AI boom. If investors think AI makes growth less inflationary and more predictable, they will pay up for duration, compressing real yields and the term premium. At the same time, the equity windfall and corporate activity surrounding AI are channeling more steady, price‑insensitive demand into Treasuries.
Whether this persists will hinge on two tests: the durability of AI‑linked productivity gains and the scale of the investment cycle required to deliver them. If productivity wins out without igniting new bottlenecks, the bond market’s AI dividend — lower real yields and tighter term premia — could endure. If the build‑out proves inflationary or capital‑hungry enough to lift the neutral rate, the current respite in long‑end yields may prove temporary.
