US bond sell-off pushes yields to decades-high levels Citadel: Economic growth and AI investment intensify capital competition

The Zhitong Finance App learned that Citadel Securities believes that the main driving force behind the recent sell-off of US Treasury bonds and the rise in yields to a decades-high level is not market concerns about further worsening inflation, but the continued strong US economic growth, and artificial intelligence (AI) investment and government deficits have intensified competition for capital. The agency pointed out that even if inflation were to ease in the future, it might not be enough to push US bond yields down significantly.

Nohshad Shah, head of fixed income sales at Citadel Securities in Europe, Middle East and Africa (EMEA), pointed out in a customer report on Monday that almost all of the increase in US 10-year Treasury yields in September was due to a rise in real yields, while overall market inflation expectations remained relatively stable.

This means that investors are re-evaluating the intensity and sustainability of US economic growth, and are demanding higher inflation-adjusted returns rather than simply seeking higher yields to withstand the risk of inflation.

The real yield on US bonds has risen, and the strong economy and AI investment have intensified capital competition

Shah said that the US economy is currently supported by fiscal easing, a relatively relaxed financial environment, and large-scale AI investment. These factors are driving real interest rates to continue to rise. He pointed out that the market is “repricing the intensity and sustainability of economic growth and the level of real interest needed to adapt to this growth.” In other words, investors are demanding higher actual returns after inflation, not simply more compensation for inflationary risks.

This logic is also closely related to the current AI investment boom. Higher potential return on investment encourages tech companies to continue to expand AI infrastructure spending, but at the same time, financing these investments, combined with the US government's continuing fiscal deficit, means that competition for capital between the private sector and the public sector is further intensifying.

In this case, the market needs more savings to meet capital requirements, or attract capital through higher real yields. Therefore, even if inflationary pressure gradually eases, US bond yields will not necessarily fall sharply.

Shah pointed out that because of this, he is unwilling to judge that US bond yields have peaked just because of falling inflation. However, at the same time, he pointed out that if the yield is to rise further significantly from the current level, new repricing is needed for economic growth, policy prospects, or term premiums.

Expecting interest rate hikes about four times in the next year, the stickiness of “reasonable” inflation still cannot be ignored

Regarding the outlook for monetary policy, Shah believes that considering that inflation is still sticky and US demand remains resilient, it is “reasonable” for the current market to expect the Fed to raise interest rates about four times in the next 12 months.

He is particularly concerned that financial support and strategically significant AI investments may make some demand less sensitive to changes in interest rates. This means that even as borrowing costs rise, some investments and spending may continue to expand, thereby weakening the dampening effect of high interest rates on economic demand.

At the same time, the trend of de-globalization and supply constraints in the real economy may also limit the room for further decline in commodity prices, making it difficult to fully offset the continuing inflationary pressure on the service sector.

Therefore, according to Citadel, the current interest rate environment facing the US economy cannot simply be understood as “rising yields due to high inflation.” The capital requirements brought about by the resilience of economic growth, fiscal expansion, and AI capital expenditure are becoming an important force in determining the level of real interest rates.

Financing costs continue to rise, and the AI investment boom will also face tests

It is worth noting that the AI investment boom itself, which is driving higher real returns, may also be counteracted by the high interest rate environment. Shah estimates that about one-third of the capital expenditure of large cloud computing companies this year was funded through debt financing. As real interest rates and financing costs continue to rise, how much cash flow AI projects can generate in the future will become increasingly important.

This means that the huge scale of AI investment alone is not enough to support the continuation of the current boom for a long time; in the end, companies still need to prove that these capital expenses can bring sufficient economic returns.

In this context, Shah reiterated that it favors large cloud computing companies such as Microsoft (MSFT.US) and Google's parent company Alphabet (GOOGL.US, GOOG.US). The business model of these companies does not only rely on selling the right to use AI models, but also has a wider range of business and monetization channels, so they have stronger support in an environment where financing costs are rising.

Shah said the AI boom could support a higher actual cost of capital, but “this cost cannot be made irrelevant.”