COLUMN-High Treasury yields could slow AI boom -Klement

By Joachim Klement

LONDON, Sept 26 (Reuters) - Tech giants are ploughing money into artificial intelligence, fueling the ongoing U.S. stock market rally in the process.

But rising long-term Treasury yields are jeopardising the investment boom in data centres and other infrastructure. Might the Federal Reserve end up bailing out these companies and the government by introducing yield curve control in 2026?

While the U.S. economy faces persistent inflation and signs of labour market weakness, U.S. stocks continue to post new all-time highs. The main source of this divergence between the economy and the stock market is investor enthusiasm for AI and the vast investments needed to run these models and store data.

Hyperscalers such as Microsoft MSFT.O, Amazon AMZN.O and Meta META.O are already investing billions in data centres and AI software. Consensus estimates show these companies are expected to increase their capex by 11% per year between 2025 and 2029. Keep in mind that these companies are on track to boost their capex by 62% year-on-year in 2025.

These companies may be at the heart of the spending boom, but the whole U.S. economy appears to have been gripped by a tech investment surge. Second-quarter GDP data in the U.S. showed that investments in IT equipment and software rose 20.4% and 12.2% year-on-year, respectively.

Tech investments explain almost all the investment growth over the last 12 months. Moreover, in the last three years, the AI boom has driven annual growth rates for IT equipment investments and software investments to 6.4% and 9.0%, respectively, far outpacing investment spending growth overall, which was a mere 1.6%.

THREAT TO AI BOOM

The fortunes of the U.S. stock market rest increasingly on hopes that the high-growth expectations for these AI hyperscalers will materialise in the next few years. But rising long-term Treasury yields could complicate this picture.

The challenge for the AI boom is that the large investments it requires need to be financed. And in many cases, a large portion of the investments will be financed by debt.

But long-term Treasury yields have been rising significantly since 2023, the latest decline notwithstanding, and could continue to drift higher in 2026.

This, in turn, would increase the cost of debt and make some investment projects unprofitable. This suggests that the higher the yield for long-term Treasuries, the lower the growth in IT equipment and software investments.

Higher Treasury yields are not going to kill growth altogether, of course, but they could certainly slow it down. And that would likely lead to downward earnings revisions for the hyperscalers and other growth stocks, given the lofty expectations baked into their valuations.

TRUMP CARD

But even if the Fed were to keep reducing the policy rate, that might not be enough. That’s because real yields for long-term Treasuries have refused to drop durably even as the Fed has started to cut rates. This could reflect a rising risk premium on Treasuries that is compensating investors for economic and political uncertainty and the possibility of higher future inflation – a premium that could rise the more investors question the Fed’s independence.

YIELD CURVE CONTROL

If long-term Treasury yields remain stubbornly high, the Fed may come under pressure to lower long-term borrowing costs through quantitative easing or full-scale yield curve control (YCC) – measures to manipulate long-term Treasury yields – as the Bank of Japan did from 2016 to 2024.

There are many reasons to expect that the Fed will become increasingly politicised in 2026, in particular under the next Fed chair in May. This means that the risk of the Fed introducing some form of YCC could be significant.

This leaves investors in a rather awkward position. In the next 12 months, rising Treasury yields could increasingly jeopardise the performance of hyperscalers and other growth stocks. But if the Fed artificially lowers long-term Treasury yields, these stocks could experience a "snap back rally" of epic proportions.

But who said investing was supposed to be easy?

(The views expressed here are those of Joachim Klement, an investment strategist at Panmure Liberum, the UK's largest independent investment bank).

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