The yield approaching 5% is not due to market doubts about the Federal Reserve; Walsh: The main drivers are the strong US economy, AI capital expenditure, and geopolitical risks.

According to Zhitong Finance APP, Federal Reserve Chair Waller stated on Wednesday that the recent continuous climb in US long-term Treasury yields does not indicate that investors are losing confidence in the Fed’s ability to control inflation. On the contrary, he believes the strong performance of the US economy, the surge in corporate capital expenditures, and rising global geopolitical risks are jointly driving up long-term borrowing costs. Among them, “hyperscale cloud service providers,” represented by large tech companies, are raising substantial funds for Artificial Intelligence (AI) and data center construction, intensifying the competition for capital in financial markets and becoming a key driver of higher yields.

Waller made these remarks after the Federal Reserve concluded its September monetary policy meeting on Wednesday. That day, the Federal Open Market Committee (FOMC) unanimously decided to raise the federal funds rate target range by 25 basis points to 3.75%-4.00%, marking the first rate hike since July 2023. In his opening remarks, Waller stated that US economic activity is expanding at a solid pace, domestic spending remains resilient, productivity growth is strong, and capital investment is quite robust. Meanwhile, inflation remains elevated, so the Fed decided to “withdraw some accommodation” to steer inflation back to the 2% target in a more timely manner.

AI capital spending surge intensifies “money race” effect

Discussing why US Treasury yields have been climbing recently, Waller, during the Q&A session of the press conference, emphasized economic fundamentals and capital demand.

Waller noted that the surge in US capital expenditures is “real,” and large cloud computing and tech companies are raising substantial funds in the market, resulting in genuine capital competition.

This statement links the recent AI infrastructure investment frenzy sweeping the tech industry with the rise in US long-term interest rates. As major tech companies continue building data centers, procuring AI chips, and expanding power and network infrastructure, related capital expenditures keep growing. Corporations raising vast amounts through bonds and other markets mean intensifying competition for capital among the government, businesses, and other borrowers.

Waller also repeatedly emphasized the strong performance of capital investment in his official opening remarks. He said the US economy appears to be further strengthening, with several indicators—such as new hires, private sector incomes, and business capital investment—showing improvement in recent months, and business credit flows particularly robust. At the same time, he argued that the current broad financial conditions can hardly be described as “tightening,” and this assessment is widely shared by FOMC members.

Waller’s view is largely consistent with that of New York Fed President Williams earlier this month. Williams previously stated that the rise in Treasury yields mainly reflects a strong US economy and outlook, which is significantly driven by the increase in investment in AI, data centers, and broader technology. Therefore, he prefers to see the rise in long-term rates as a reflection of economic strength.

Geopolitical risks also drive long-term yields higher

Apart from economic growth and capital expenditure, Waller also identified global geopolitical situations as another key factor driving long-term rates higher.

He noted that developments in several global hotspots are pushing long-term yields up. Their impact is not only reflected in spot price increases for commodities like energy, corn, soybeans, or wheat but also transmitted through refining margins, and processing and supply chain costs, which ultimately reach the prices of goods in US stores.

In fact, Waller specifically mentioned geopolitical shocks and uncertainty in his opening remarks, noting that under such circumstances, the US economy has still shown considerable resilience. The Fed also pointed out that the US unemployment rate remains at a relatively low level of about 4.1%, job vacancies and weekly hours worked have both increased, and the four-week average for initial jobless claims still aligns with full employment.

This also forms an important economic backdrop for the Fed’s renewed rate hike this time. Despite significantly higher long-term rates, the labor market has not deteriorated, and economic activity and capital investment remain resilient.

Does not agree the “market lost confidence in the Fed’s fight against inflation”

It is worth noting that Waller did not include market loss of confidence in the Fed’s anti-inflation abilities among his reasons for the rise in long-term yields.

After US government debt exceeded $40 trillion, fiscal deficits and debt sustainability have been seen by some market participants as important potential factors for rising long-term Treasury yields. However, Waller did not include fiscal deficit concerns among his main explanations for long-term rate increases.

On the contrary, he emphasized the impact of US economic growth, capital investment, and geopolitical factors on long-term rates.

This does not mean Waller believes inflation risks have dissipated. On the contrary, he sent a clear anti-inflation signal at the press conference that day.

Waller stated that US inflation has been above the Fed’s target for more than five consecutive years, so the current policy focus remains on the “price stability” component of its dual mandate. He bluntly said, “The fact is simple: inflation is too high, and has been high for too long.”

According to data he disclosed at the conference, based on the latest CPI and PPI estimates, the year-on-year increase in overall US PCE for August may reach around 3.6%, with core PCE and core CPI running at about 3.2% and 2.4%, respectively. Waller specifically pointed out that whether over the past 6 months or 12 months, too many categories of goods and services still have price increases exceeding 3%, and recently, the input costs of various critical commodities have also risen.

The market did not “force” the Fed to hike rates

The recent surge in US Treasury yields also became a crucial factor for markets assessing the Fed’s September policy path. Before this meeting, investors were heavily betting that the Fed would raise rates by 25 basis points, with some market watchers even worried that if the Fed chose not to act, it might undermine its anti-inflation credibility and further propel long-term Treasury yields higher.

However, Waller explicitly rejected the notion that market pricing “forced” the Fed to act. He stated that, of course, he observes market prices and pays attention to the signals they send, “but today’s decision was ours alone.”

Waller emphasized that what he expressed at the Jackson Hole global central bank summit at the end of August was the discipline of monetary policy, not a pre-commitment to any specific policy move. At that time, he said the criteria for action were that the Fed needed to be sure underlying inflation was “clearly and quickly enough” falling toward the 2% target.

At this week’s meeting, the FOMC judged that this condition had not been met, so the committee unanimously decided to hike rates. Waller stated the unanimous vote demonstrated the Fed’s determination to restore price stability in a more timely manner.