US Treasury Sell-off Pushes Yields to Decades-Highs; Citadel: Economic Growth and AI Investment Intensify Capital Competition

According to Zhitong Finance APP, Citadel Securities believes that the recent sell-off in U.S. Treasury bonds and yields reaching multi-decade highs are mainly driven not by concerns of worsening inflation, but by the continued strength of U.S. economic growth, as well as increased competition for capital caused by artificial intelligence (AI) investments and government deficits. The firm points out that even if inflation eases in the future, it may not be sufficient to significantly drive U.S. Treasury yields lower.

Nohshad Shah, Head of Fixed Income Sales for Citadel Securities in Europe, Middle East, and Africa (EMEA), noted in a client report on Monday that nearly all of the increase in the U.S. 10-year Treasury yield in September was due to rising real yields, while overall market inflation expectations remained relatively stable.

This means that investors are reassessing the strength and sustainability of U.S. economic growth and are seeking higher inflation-adjusted returns, rather than simply demanding higher yields to offset inflation risk.

U.S. Treasury Real Yields Climb: Robust Economy and AI Investment Intensify Capital Competition

Shah stated that the U.S. economy is currently being supported by fiscal easing, a relatively accommodative financial environment, and large-scale AI investments, all of which are pushing real interest rates higher. He noted that the market is “repricing the strength and sustainability of economic growth and the real rate levels needed to accompany it.” In other words, investors are demanding higher actual returns after inflation, not just more compensation for inflation risk.

This logic is closely related to the current AI investment boom. Higher potential returns are encouraging tech companies to continue expanding their AI infrastructure spending. However, financing for these investments, coupled with the U.S. government's persistent fiscal deficits, intensifies the competition for capital between the private and public sectors.

In such an environment, the market needs more savings to meet capital demand or must attract capital with higher real yields. Therefore, even if inflationary pressures gradually subside, U.S. Treasury yields may not necessarily fall sharply as a result.

Shah pointed out that for this reason, he is unwilling to judge that U.S. Treasury yields have peaked simply because inflation is falling. However, he also noted that for yields to rise significantly from current levels, there would need to be a fresh repricing of economic growth, policy outlook, or term premium.

Expectations of About Four Rate Hikes in the Coming Year Are “Reasonable;” Sticky Inflation Remains a Concern

Regarding monetary policy, Shah believes that, given inflation remains sticky and U.S. demand stays resilient, the current market expectation that the Federal Reserve may raise interest rates about four times in the next 12 months is “reasonable.”

He is particularly concerned that fiscal support and strategically significant AI investments could make parts of demand less sensitive to rate changes. This means that even as borrowing costs rise, some investment and spending may continue to expand, weakening the effect of higher rates in suppressing economic demand.

At the same time, deglobalization trends and supply constraints in the real economy may also limit further declines in commodity prices, making it difficult to fully offset persistent inflationary pressures in the service sector.

Therefore, in Citadel’s view, the current U.S. interest rate environment cannot simply be interpreted as “rising yields driven by high inflation.” The resilient economic growth, fiscal expansion, and capital demand from AI investments are collectively becoming the key forces determining the level of real rates.

Rising Financing Costs: The AI Investment Boom Will Also Be Tested

It is worth noting that the AI investment boom, which is driving real yields higher, may also be affected by the high-rate environment. Shah estimates that about one-third of large cloud provider capital expenditures this year are financed through debt. As real rates and financing costs continue to rise, the ability of AI projects to generate cash flow will become increasingly important in the future.

This means that the sheer scale of AI investments is not enough to sustain the current boom over the long term; companies will ultimately need to demonstrate that these capital expenditures can provide sufficient economic returns.

Against this backdrop, Shah reiterated a preference for large cloud computing providers like Microsoft (MSFT.US) and Google’s parent company Alphabet (GOOGL.US, GOOG.US). The business models of these companies rely not just on selling access to AI models, but on broader business and monetization channels, giving them greater support in a rising-cost environment.

Shah stated that the AI boom can support higher real capital costs, but “cannot make those costs irrelevant.”