What’s Going On With Interest Rates?

Since the end of February, interest rates have moved sharply higher, both in the United States and around the world. The U.S. 10-year Treasury yield has risen by more than 109 basis points, while the 30-year mortgage rate has increased by roughly 94 basis points. The move has been felt abroad as well, with France’s 10-year yield up by approximately 137 basis points, Germany’s by 84 basis points, and Japan’s by 84 basis points.

For many government-bond markets, yields are now near the highest levels seen since the Global Financial Crisis. This matters because higher rates raise the cost of capital for everyone, including governments, companies, and consumers. Borrowing becomes more expensive, interest costs rise, and assets that benefited from years of low rates come under pressure.

Despite President Trump’s preference for rates closer to 1%, the bond market has been moving in the opposite direction. The market is signaling that inflation, government borrowing, and the demand for capital remain too high for rates to fall meaningfully in the near term.

The move toward higher rates began with the U.S.–Iran conflict at the end of February. The immediate increase in crude-oil prices created concern that inflation would remain higher for longer.

Higher oil prices affect nearly every part of the economy. They raise transportation, manufacturing, and consumer costs, all of which can quickly push inflation expectations higher. As a result, once investors begin to worry that inflation is here to stay, they demand higher yields to own bonds.

Normally, geopolitical conflict drives investors toward the safe haven of government bonds. This time, however, inflation fears outweighed the typical flight-to-safety trade. Investors have been more concerned that high oil prices, increased defense spending, and supply disruptions would keep inflation elevated.

The situation has become more complicated as the Russia–Ukraine war has intensified. Ukrainian drone attacks on Russian refining infrastructure has added increased pressure to the global energy market at a time of greater instability in the Middle East. The result has been a higher oil-risk premium and a growing belief that inflation may not ease as quickly as investors had hoped.

The next driver of higher rates has been monetary policy.

Kevin Warsh took office as Federal Reserve Chair in May and was initially viewed as someone who could support lower rates. However, stronger inflation readings and higher energy prices has put the Fed in a difficult position. Cutting rates too quickly risks making inflation worse and could create the perception that the Federal Reserve is following political pressure rather than economic data.

Contrary to the wishes of the White House, the Fed ended up raising rates by 25 basis points at their September meeting. What has become more important is the Fed’s message that additional tightening may be necessary if inflation does not improve.

The U.S. is not alone. The ECB and the Bank of Japan have also maintained a more restrictive posture. When the other major central banks around either raise rates or keep policy tight, global bond yields tend to move higher together. In the United States, 10-year Treasury yields have passed 5%, while 10-year yields in Germany, France, and Japan have also moved to multiyear highs.

Inflation and central-bank policy are only part of the story, however. Another major factor is the amount of debt coming to market.

Governments around the world continue to run large deficits, with the U.S. deficit above $1.7 trillion, or about 5% of GDP. In France, the United Kingdom, and in Japan, fiscal deficits also remain elevated. As governments issue new bonds to finance these deficits, the increased supply can push yields higher as investors demand greater compensation to absorb the additional debt.

Investors are not necessarily worried that the U.S. will default. The concern is that persistent deficits mean the market will need to accommodate the large amount of Treasury issuance for years to come. To attract enough buyers, the government may need to offer higher yields.

Corporate debt issuance has also increased. The buildout of AI infrastructure, including data centers, power systems, networking equipment, and computing capacity, requires large amounts of capital. Leading technology and AI-related companies have increasingly shifted from funding data-center expansion solely through internally generated cash flow toward using debt markets to support the scale and speed of investment required.

More than $350 billion of debt has been issued by leading AI companies over the past year. That amount of corporate issuance adds competition for capital at the same time governments are issuing record levels of debt. When both governments and corporations need substantial funding, bond investors can demand a higher return.

The most likely outcome is that rates remain elevated for longer than many investors expected.

Yet, rates cannot move dramatically higher forever. The U.S. government is already expected to spend roughly $1 trillion on annual interest expense, and higher rates make that burden grow quickly. Companies with large refinancing needs also feel the impact, along with consumers relying on mortgages, auto loans, and credit cards.

Still, it will be difficult to bring rates down quickly.

The key question is whether inflation begins to cool without a major disruption in economic growth. If oil prices decline, geopolitical risks ease, and inflation moves closer to central-bank targets, yields could stabilize and eventually fall. But unless conditions improve, the market is likely to continue demanding higher returns for lending money to governments and corporations.