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United States (US) government bond yields have risen sharply over the past month. The 30-year Treasury yield rose from around 5.05% in mid-July to as high as 5.27% in the first week of September, an increase of 22 basis points, taking it to its highest level since 2007. The 10-year yield has also moved materially higher, reaching around 4.68% at its recent peak. The move matters because it represents a significant increase in the price the US government must pay to borrow for long periods, while also raising the benchmark cost of capital across the wider global financial system. But the implications extend to matters far beyond that and arguably much more important.

The chart below shows the yields of the 10-year and 30-year treasuries.

A first qualifying statement if you look at the chart is that yields are high relative to what they were around 2007, but they are not high relative to the long-term moving average before that. The idea therefore of spiking yields needs to be weighed against an understanding that the extremely low interest rate era of the period since the global financial crisis is coming to an end. That does not alter the fact, however, that borrowing costs are spiking relative to what they were for the balance of the past 15 or 20 years and that this will have very sharp political and fiscal consequences.

[A quick note on terms and ideas. Governments issue bonds to raise money. Bonds are essentially IOUs. Investors buy these bonds and then trade them. Governments promise to pay investors who buy the bonds an annual “coupon” rate to hold the bonds. The coupon is a set amount, but as the bonds are traded their price can rise and fall. As they do, the coupon expressed as a percentage of the value of the bond rises or falls. This becomes the interest rate of the bond, called the yield. When demand for the bonds is strong then their price goes up, reducing their yields – remember, the coupon is a constant amount. But when investors are nervous or less interested in buying bonds, their price falls and the yield rises. Broader interest rates in an economy tend to follow what is happening with yields, even if the central bank does not raise interest rates. Sometimes when yields are very high a government will try to buy its own bonds in order to raise demand and thereby reduce yields. This is usually done by its treasury department. Sometimes treasury departments do this by swapping long-term bonds for short-term bonds, like using your credit card to reduce your home loan debt. At other times they need their central banks to “print” money to help them do this. The more bonds they issue the higher their national debt goes.]

In its note, the firm set out a number of reasons for the recent yield spike.

The first is inflation expectations, which it estimates account for around a modest 5% of the move. While some inflation concerns remain, the US two-year break-even inflation rate has fallen from its Iran War peak of 2.97% in March to 1.90% this past week. That suggests markets have unwound much of the inflation risk premium associated with the war. This is shown in the chart below.

[The US two-year break-even inflation rate is the difference in interest paid on normal bonds and inflation-related bonds and gives an indication of what the market expects inflation to be in future.]

A further 10% is attributed to Warsh’s communication strategy. Warsh has provided relatively little forward guidance about Fed policy, meaning investors are demanding some compensation for greater uncertainty around the future path of monetary policy.

Another 10% is attributed to growing friction in the global economy caused by tariffs and the onshoring of production. Both reduce the efficiency with which capital is allocated and therefore increases the returns investors demand.

A fourth factor, accounting for a relative 15%, is that returns on US equities have been very strong and have drawn capital out of the bond market.

[Note that these percentages are simply a device to indicate the relative extent to which a range of factors have contributed to the higher US yields.]

The largest single factor is the US government’s rapacious appetite for capital, to which the firm assigns 35% of the move.

Neither side of the American political divide presently appears willing to impose serious spending restraint. The implication is that US government borrowing will continue to increase. All else being equal, rising demand for capital increases its price, reflected in higher yields.

The remaining 25% is attributed to exceptionally strong private-sector demand for capital, particularly from companies investing in artificial intelligence (AI) infrastructure.

AI-related companies are raising enormous amounts of debt, with corporate yields competing directly with government bonds for investor capital. The issuance of AI corporate debt as a share of US Treasury issuance is shown in the chart below:

The firm argues that while those factors explain the lift in yields, that is not the most important thing. Behind them “two titanic battles are playing out that interest us enormously. One is domestic to the US. The other is global.”

“On the domestic front is Bessent versus ‘Warsh the hawk’. Bessent’s intervention in the bond market, swapping long-term debt for shorter-term debt, has not worked to tame yields. Assume, for the sake of argument, that is not going to work at any point. What then? One of the answers is that the Fed must step in and issue new money to buy long-term debt and suppress yields. Warsh does not want to do that. We are fairly certain Warsh is testing the waters to take on the American establishment, to do what neither side of the political aisle can or will, and to tame the deficit and get Congress off the heroin of cheap money. How that battle plays out has enormous implications for the US economy.”

Turning to the global front, the firm says, “The yield spike says something about the idea of the dollar as the world’s ultimate safe haven and, more importantly, about de-dollarisation. Remember that one of our firm’s big global arguments is that the primary US-versus-China battlefield of the next 20 years will be the reserve status of the dollar more than almost anything else. Erode that status and the US becomes less able to finance its deficits via printing – push that far enough, or force that reality onto America from without, and economic mayhem may ensue, leading to political mayhem on a scale never seen before. At the same time, America’s ability to lend globally is reduced, undercutting perhaps its most important source of diplomatic leverage. The net result is that America is severely weakened at home and abroad.

“We have previously shared data on the declining share of global reserves held in dollars, changes in the renminbi-to-US-dollar ratios passing through SWIFT, China’s own alternative to SWIFT (and how the daft decision to cut Russia off SWIFT accelerated that), and Chinese gold buying. We know this de-dollarisation business to be the central element of the Chinese strategy to undercut the US and the wider West.”

The chart below shows the declining share of global reserves held in US dollars.

The next chart shows the relative share of renminbi to dollars passing through the SWIFT interbank payment system.

The chart below shows China’s gold reserves since 2000.

According to the firm, the very long-term implications suggested in these charts for the future of the dollar as the dominant reserve currency “is something that a small thinking circle of US hawks understand. They know that America needs to wean itself off the heroin of cheap money on its own terms before that is forced on it from outside, to the great advantage of its greatest global rival. That is important in corroboration of what we argue Warsh may be doing – it is not just fiscal and monetary strategy at play, but must be read as something very much greater than that.”

The firm argues that Warsh is testing the waters to see if the Fed can do what Congress cannot and that by leaving the Treasury exposed and impotent in the face of spiking yields, force Washington to confront and deal with the consequences of its spending recklessness while it still has time to do so on its own terms and not on terms forced on it by outside actors. Congress cannot stop borrowing because the effects would be politically ruinous for the party in power, Democrat or Republican, hence both carry on borrowing to spend more and more even though this places the US economy in an increasingly vulnerable long-term position.

US government debt has surged to more than $40 trillion for the first time, having increased by roughly $3 trillion in the past year alone, the fastest increase outside the pandemic period. The debt burden has more than doubled from $19.95 trillion in 2017, while debt held by the public, meaning the portion owed to outside investors such as banks, pension funds, and foreign governments, now stands at about $32.3 trillion, equivalent to roughly 101% of US GDP. The remaining $7.7 trillion is money the US government owes itself, held almost entirely by federal trust funds, chiefly those for Social Security and Medicare. Persistent annual deficits are driving the increase, with the Congressional Budget Office expecting a deficit of around $1.9 trillion in 2026. The result is that the US government must continually issue enormous volumes of new debt at precisely the time that investors are demanding higher yields to hold it.

Just look at the chart below, which shows the implications for US interest spending of the debt surge in an environment of spiking yields.

The chart shows that interest payments have spiked to an over 2.0X multiple of what they were for the past two decades, taking the figure back to what it was last in the early 1990s. The implication for US government spending is dire.

The firm suspects that Warsh’s refusal to provide extensive forward guidance arises in part from his determination to cut off the “heroin”. Rather than explicitly telling investors that the era of exceptionally cheap money is ending, which would have dramatic market consequences, he is allowing investors to reach that conclusion themselves, and the clever ones to reach it before the others, allowing them to position accordingly, which will moderate the effect – rather like slowly getting into a cold bath as opposed to being dunked in a tub of freezing water.

The immediate implications for interest rates are straightforward enough.

The Federal Reserve can presently afford to leave its policy rate unchanged because rising market yields are already tightening financial conditions – and doing Warsh’s job for him. Bond yields can remain detached from the Fed funds rate for a considerable period. The Fed therefore has little reason to raise rates unless inflation indicators deteriorate materially. And for now, the break-even inflation rate suggests that inflation expectations remain relatively contained.

This is shown in the chart below:

[Rising interest rates make money more expensive, thereby doing what is called tightening economic conditions. This is necessary at times to fend off inflation, remember that inflation is caused by only one thing: central banks printing money faster than the increase in the value of goods and services created in an economy.]

The position facing emerging-market central banks is more difficult than that facing the Fed.

Higher US yields increase the returns investors can earn on dollar assets and reduce the relative attractiveness of emerging-market assets. That puts pressure on central banks such as the South African Reserve Bank (SARB) to maintain a sufficient interest rate differential against the US. The firm therefore argues that the rise in US yields has increased the probability of at least a 25-basis-point SARB rate hike before the end of 2026.

The firm is advising its clients to get an early read on what may be coming down the line from the US Fed, to understand why the motivation behind that may be existential to the long-term security and the stability of the US, and to prepare their positions accordingly.