*** Through Election Day I’m offering a 40 percent discount on all Doom subscriptions — $3.60 a month to support our work holding Trump and Republicans accountable for their election interference plans. Access the discount here. ***
Economics and politics share one commonality that can be very frustrating to people who are experts in both fields — feelings often outweigh facts.
That the economy is technically doing relatively well doesn’t change the feeling of many Americans that it is not. Lately, most of that negative perception of the economy comes from high gas prices, which the vast majority of Americans cannot avoid thanks to decades of failure to properly invest in mass transit.
While the state of the U.S. economy is a complex matter, it does not change our natural reaction to look for someone or something to blame. In the U.S., that often means the president. Presidents have little control over gas prices, but one very simple way to ensure that they remain stable is to not start a war and cut off the flow of oil from the Middle East. Hence, even many supporters of Donald Trump are correctly blaming him for prices at the pump.
Trump’s war in Iran is making everything more expensive, as I reported today at Public Notice. Plus, the world is even less sure of American leadership thanks to Trump’s actions in the Middle East, his volatile trade policies, and his and Republicans’ complete lack of action on reducing the national debt.
As part of my reporting, I spoke to Rodney Sullivan, executive director for the Mayo Center for Asset Management and a professor of economics at the University of Virginia’s Darden School of Business. Like many economists, Sullivan points out that our skyrocketing debt is a major reason why markets are losing confidence in the U.S. economy. There’s also the possibility of a looming AI bubble, which is driving up borrowing costs for everyone from folks looking to buy a house to the U.S. government itself.
We begin our conversation with Treasury yields, a benchmark for the U.S. economy that help to determine interest rates on everything from mortgages to car and credit card loans. Those yields recently hit numbers not seen since just before the 2008 global financial crisis — a dire warning sign that, despite the relative health of the economy, things may be headed in the wrong direction.
***
JG: Treasury yields have been on the rise for some time now. Deficits are continuing to increase at a high rate. Consumer rates and in particular mortgage rates are tied to these rates. What in your opinion needs to be done by the government to change this trajectory to make mortgages/lending affordable for the average American?
RS: There are two important policy channels that could bring down borrowing costs. First, monetary policy must restore confidence that inflation will return durably to the Federal Reserve’s target. The Fed has made clear that it is committed to reducing inflation and restoring price stability. Today, the FOMC raised the federal funds rate by 25 basis points, to 3.75%–4.00%. Markets had anticipated that increase, but they appear to view it as the beginning of a broader tightening cycle rather than a one-time adjustment. Although the Fed does not directly control 10-year Treasury yields or mortgage rates, its actions influence investors’ expectations about future inflation and short-term interest rates. If the Fed demonstrates that it is willing to keep policy restrictive for as long as necessary, it could restore its credibility as an inflation fighter. That could cause long-term yields to fall relatively quickly, even if short-term rates initially rise further.
Second, the federal government needs to address the country’s deteriorating fiscal position. Total public debt recently surpassed $40 trillion, and net interest costs have risen above $1 trillion annually—roughly comparable to national defense spending. With the federal deficit currently around 6% of GDP and expected to remain elevated, investors are demanding greater compensation to hold long-term Treasury securities.
A credible, multiyear plan to reduce future deficits would directly address those concerns. Such a plan would likely require some combination of slower government spending growth—including reforms to entitlement programs—and higher tax revenue. The goal would not necessarily be immediate austerity, which could weaken the economy, but a believable commitment to place the debt trajectory on a more sustainable path. If policymakers simultaneously restored confidence in price stability and adopted a credible fiscal plan, Treasury yields could fall substantially and potentially quite rapidly. Lower Treasury yields would, in turn, reduce the cost of mortgages and other forms of consumer and business borrowing. The government cannot dictate long-term rates, but it can materially influence the expectations and investor confidence that determine them.
JG: There are two seemingly opposing arguments being made: That yields are rising because of lack of trust in the U.S. government/financial stability, and that rates are rising because there is a boom of companies seeking loans for expanding operations, causing the government to have to compete in a narrow space. Which of these do you subscribe to?
RS: I would not view these as mutually exclusive explanations. Bond yields are influenced by several forces, including expected inflation, economic growth, Federal Reserve policy, and the balance between the government’s borrowing needs and investor demand for bonds. Higher oil prices can increase inflation and lead investors to expect interest rates to remain elevated for longer. Geopolitical conflict can have a similar effect if it disrupts energy supplies. At the same time, geopolitical stress can increase demand for safe-haven assets such as U.S. Treasuries, so its effect on yields is not always one-directional. The government’s large and growing borrowing needs are a longer-term concern. More Treasury issuance requires investors to absorb more bonds, while higher interest rates increase the government’s costs as existing debt is refinanced. The May 2025 Moody’s downgrade underscored these concerns.
The AI buildout may also increase demand for capital, particularly as technology companies and data-center operators invest heavily in computing capacity, energy infrastructure and facilities. But I would be cautious about describing this as a direct competition between corporate borrowers and the U.S. Treasury for a fixed pool of funds. Global savings, foreign investors, banks and other financial intermediaries influence the supply of capital. Corporate investment may contribute to higher real interest rates at the margin, but it is unlikely to be the primary explanation for the recent rise in Treasury yields.
There is also a more positive interpretation: some of the increase in yields reflects an economy that is stronger than it was during the unusually low-interest-rate period following the global financial crisis and during the pandemic. The recent rise in 10-year TIPS yields alongside nominal Treasury yields is consistent with higher expected real interest rates, although it may also reflect a higher real term premium.
Overall, Treasury yields reflect expected growth, inflation, investor demand, government borrowing and confidence in future fiscal policy. A bond-market crisis is a much stronger conclusion than the available evidence supports.
JG: Barring the possibility of some type of recession, is the downside here that we could simply be entering a new/renewed era of higher interest rates? In previous eras of high interest rates, have bond yields been this high?
RS: That is one plausible interpretation. Interest rates may be normalizing toward levels that were more typical before the unusually low-rate period following the global financial crisis. From roughly 2000 to 2008, the 10-year Treasury yield was generally in the 4% to 5% range—closer to today’s levels than to the exceptionally low yields that prevailed during much of the 2010s and the pandemic. Yields were substantially higher still during the inflationary period of the 1970s and early 1980s.
The important question is not whether yields are higher than they were recently, but whether they remain persistently high. That will depend on the path of inflation, real economic growth, Federal Reserve policy and the government’s fiscal trajectory. Higher rates may be a “new normal,” but they could also decline if inflation falls, growth weakens or fiscal concerns ease.
JG: Optimistically, AI’s role in companies seeking lending is a sign that they are expanding operations, innovating, creating jobs, etc. But pessimistically, couldn’t this all be one big bubble? I.e. companies gobbling up tons of capital in loans that they’re not going to be able to pay back because AI isn’t worth as much as they think it is?
RS: Yes, that is a meaningful risk. The AI buildout is based on the expectation that demand for computing power, software and related infrastructure will continue to grow rapidly. If that demand falls short of expectations, companies that have invested heavily or borrowed substantially could face lower revenues, weaker profits and difficulty servicing their debt.
That would not necessarily mean that the entire financial system is at risk, but it could produce significant losses for lenders, investors and companies exposed to the buildout. The dot-com experience is instructive: excessive investment and unrealistic expectations eventually led to a sharp market decline and the failure of many companies. At the same time, several businesses that survived that period—for example, Amazon, Microsoft and Apple—went on to generate extraordinary long-term growth. Meta, which was founded after the dot-com bust, illustrates a related point: companies that emerge from a subsequent technological cycle can also become highly successful.
The same distinction is important today. AI appears to represent a genuine technological transformation, while some individual companies, projects and valuations may nevertheless prove unsustainable. The central question is whether future cash flows will justify the capital being committed today. That requires investors and lenders to distinguish carefully between durable economic value and enthusiasm that has temporarily inflated expectations. A severe market correction is possible, but it is not an inevitable outcome of the AI revolution.
JG: Is there a theory here that with the Fed rate hike, businesses will increase prices and lenders will increase things like mortgage rates, therefore driving down demand and eventually resulting in lower prices?
RS: Yes, that is the basic theory, although businesses do not necessarily raise prices because interest rates increase. The main intended effect of the Fed action today is to reduce demand. Higher policy rates generally lead to higher borrowing costs for businesses and consumers. Consumers may pay more for auto loans, mortgages and credit-card balances, while businesses face higher costs for financing inventories, equipment and expansion. Those higher costs can cause households and companies to postpone spending.
Over time, weaker demand should make it more difficult for businesses to raise prices and may reduce the rate at which prices increase. In that sense, monetary tightening is intended to slow demand enough to bring inflation down without causing a severe contraction in economic activity.
The process operates with a lag, however, and not all borrowing costs move together. Mortgage rates, for example, are influenced heavily by longer-term Treasury yields and mortgage-market conditions rather than by the federal funds rate alone. Moreover, the recent rise in interest rates reflects several forces as I mentioned earlier—including persistent inflation, strong economic growth, fiscal concerns and increased Treasury issuance—so it will be difficult to isolate immediately how much of any subsequent decline in inflation is attributable specifically to [last week’s] Fed action.