Long-term US Treasury sell-off intensifies; Federal Reserve officials deny credibility is in question—government borrowing and competition for capital with AI financing are the main reasons

According to Zhitong Finance APP, U.S. long-term Treasury bonds have recently faced continued sell-offs, with the 30-year Treasury yield briefly rising to the highest level since 2007. Regarding market concerns that rising Treasury yields may indicate that investors are questioning the Federal Reserve's ability to control inflation, two Fed officials downplayed this on Thursday, suggesting that the U.S. government's large financing needs and the capital demand driven by artificial intelligence infrastructure construction are the main factors pushing long-term yields higher.

St. Louis Fed President Musalem said in an interview on Thursday that the global capital markets are currently experiencing increasingly fierce “competition for capital.” On one hand, the U.S. government needs to finance fiscal spending through large-scale Treasury issuance; on the other hand, artificial intelligence infrastructure construction similarly requires massive capital investment, and this financing demand has expanded from the U.S. to a global scale.

Musalem stated: “Government financing needs, coupled with AI infrastructure financing, are currently forming a competition for capital.” He also emphasized that long-term market inflation expectations remain stable, so the recent bond market sell-off does not indicate that investors are questioning the Fed’s policy credibility.

Generally speaking, if investors think the Fed’s determination to control inflation is insufficient, they may also demand higher long-term bond yields as compensation. However, Musalem believes there is currently no clear evidence that this is happening.

Recently, the U.S. Treasury market has been under obvious pressure, especially for long-term bonds. Investors continue to sell off U.S. Treasuries, pushing the 30-year yield to its highest since 2007. Market concerns mainly center on the rapid expansion of U.S. government debt, increased fiscal financing needs, and the fact that inflation has exceeded the Fed’s 2% target for more than five consecutive years.

On Wednesday, U.S. government debt exceeded $40 trillion for the first time. Meanwhile, the AI investment boom is pushing tech companies and infrastructure developers to raise large amounts of capital for building data centers, purchasing chips, and securing power resources. The simultaneous competition for long-term capital by the government and enterprises is also considered to be driving up overall financing costs.

San Francisco Fed President Daly expressed similar views in an interview on the same day. She stated that she does not believe the Fed’s policy credibility is at risk and also sees no evidence that the Fed urgently needs to preemptively raise rates to stabilize the market.

Daly believes that the performance of the U.S. Treasury market may actually indicate that the current stance of monetary policy is generally appropriate. She also pointed out that when analyzing policy signals from bond prices, the enormous capital demands brought by AI products and infrastructure investments must be taken into account.

The U.S. Treasury Department announced on Wednesday that it is expanding long-term Treasury buybacks in hopes of improving market liquidity and alleviating selling pressure on long-end bonds. Following the announcement, long-term yields fell notably, but the effect was short-lived, with most of that drop recovered by Thursday. Daly declined to comment directly on the Treasury's action to expand bond buybacks.

Although Musalem believes the recent bond market sell-off is not a Fed credibility crisis, his attitude toward inflation risks is noticeably more hawkish.

Musalem said he was initially inclined to support a rate hike at the Fed’s July policy meeting to further suppress still-elevated inflation. He believes that if rates are not raised further, the likelihood that inflation will not fall back to the Fed’s 2% target within the next 18 months is increasing.

At the July meeting, the Fed kept rates unchanged for the fifth consecutive time, without giving a clear signal of an imminent hike. At the time, three policymakers voted in favor of raising rates, and some regional Fed officials without this year’s voting rights, including Musalem, also expressed a preference for further tightening monetary policy.

In contrast, Daly's stance is more cautious. She said she supported the Fed's decision to keep rates unchanged in July, and currently does not see clear signs of inflation becoming broader or more persistent.

Daly noted that recent inflation and employment data have not significantly altered her assessment of the economy. She expects that the price shocks from tariffs, rising oil prices, and AI investment may ultimately prove temporary. With current monetary policy still somewhat restrictive, she believes inflation is likely to return to a downward trend.

As a labor economist, Daly also pointed out that there is currently no new and obvious inflationary pressure arising from the U.S. job market.

In fact, a series of economic data released since the Fed's July meeting have reduced market expectations for short-term rate hikes. Inflation data for June and July showed some easing of price pressures, while retail sales fell in July and the job market unexpectedly experienced job losses.

As a result, the market’s expectations for a rate hike in September have cooled significantly. Traders now see the probability of a September Fed rate hike at around 30%, far below the over 70% level at the end of July.