What’s really driving the rise in Treasury yields?

The rise in Treasury yields is primarily a repricing of real rates and real term premia, not a material increase in inflation expectations.

• A D’Amico-Kim-Wei decomposition shows that more than 70% of the increase in the 10-year Treasury yield since the end of February came from higher expected real short-term rates and the real term premium; real yields also rose in the UK and Germany.
• Treasury supply is a longer-term fiscal risk, but first-half gross note and bond issuance was not materially different from the second half of last year, while bid-to-cover ratios, primary-dealer takedowns and auction tails remained broadly orderly compared with the stress of the second half of 2023.
• Policy repricing and uncertainty have increased: the average absolute two-year yield reaction around FOMC meetings has been larger since Kevin Warsh became Fed chair, while option markets show a wider and more upward-skewed range of policy outcomes.
• AI investment may increase competition for capital: US dollar investment-grade issuance is about 30% higher year to date, roughly 24% of this year’s supply is AI-related versus around 6% in euros, and Goldman Sachs estimates 2027 gross corporate issuance at about $2.4 trillion.
• Market data reinforce the conclusion: the 10-year real TIPS yield is around 65 basis points above its February average, while 10-year breakeven inflation is only about 7 basis points higher; measured total-factor productivity remains negative after adjusting for capital and labour utilisation.

Takeaway: With 10-year TIPS near 2.5%, real yields offer a materially improved inflation-adjusted prospective return, but AI-related borrowing, policy uncertainty and a possible future rise in productivity could keep yields and term premia elevated rather than returning quickly to pre-2023 levels.