Economic Resilience, AI Investment Push Bond Yields Higher

Bond yields are rising sharply, with 10-year Treasury yields hitting 5.2%, the highest since 2007, and 30-year yields climbing to 5.5%, a level unseen since 2004. Seema Shah, chief global strategist at Principal Asset Management, argues that while multiple factors are at play, market pricing reveals some forces are more influential than others.

Economic Resilience and AI Investment Drive Yields

Shah highlights that the primary drivers are economic resilience and AI-related investment demand. Large-scale investments in AI infrastructure are boosting capital demand, contributing to higher real interest rates. Shah notes that these investments have been insensitive to rising borrowing costs, allowing equity markets to absorb higher yields better than in the past.

Inflation and Fiscal Concerns Take a Backseat

Shah emphasizes that inflation expectations and fiscal risks are not the main drivers. Inflation expectations, measured by breakeven yields, remain stable despite recent oil price increases. Similarly, there is limited evidence of a broad fiscal repricing, as a genuine fiscal shock would likely trigger more pronounced market reactions.

Instead, the sell-off in bonds has been driven by a rise in real yields, indicating investors are reassessing growth, policy expectations, and capital demand. Markets now anticipate further Fed rate hikes in 2026 and 2027, particularly if oil prices remain above $100 per barrel.

Equities Hold Steady, but Risks Loom

The equities market has responded with relative calm, with the S&P 500 hovering just 1% below its record high. Shah warns that higher yields could eventually pressure valuations and increase market volatility.

As bond yields rise, fixed income becomes more competitive with equities, potentially squeezing margins for error. Companies with strong earnings momentum and durable growth trends may fare better, while rate-sensitive sectors could face greater challenges. Shah advises a selective approach, as fundamentals remain supportive but raised rates leave little room for disappointment.