Bond yields have been rising for five years and the era of abundant capital is gradually giving way to one of greater competition for capital, in a new investment cycle driven by artificial intelligence (AI), with more persistent inflationary uncertainty, higher nominal growth and larger fiscal deficits.
Analysis by Lauréline Renaud-Chatelain
For more than four decades, the global economy operated in an environment of falling interest rates and abundant capital, thanks to fiscal consolidation, globalisation and technological progress, which generated powerful disinflationary forces, allowing bond yields to fall to historic lows following the Covid-19 pandemic in 2020.
But bond yields have been rising for five years and the era of abundant capital is gradually giving way to one of greater competition for capital, in a new investment cycle driven by artificial intelligence (AI), with more persistent inflationary uncertainty stemming from commodities, higher nominal growth and larger fiscal deficits, which are likely to increase alongside the need for social spending as populations age and the labour force shrinks in developed economies.
In this environment of high fiscal deficits and rising financing needs, we expect central banks to remain highly active and pragmatic in using their toolkit, whilst remaining vigilant to inflationary pressures and preserving their credibility – which is key to anchoring long-term bond yields. However, as they are forced to live with or tolerate a sustained deviation of inflation from their target – “3 per cent is the new 2 per cent” – the floor for bond yields to maturity will rise, and these yields are unlikely to return to the near-zero equilibrium that prevailed for much of the period following the global financial crisis.
We therefore expect the Federal Reserve’s policy rate to stabilise at around 3.25–3.5 per cent and the ECB’s deposit rate at around 2.25 per cent, with the Swiss National Bank’s rate close to zero being the main exception.
In any case, the attractive nominal yields on US and UK debt, as well as debt from certain emerging markets, are likely to continue to attract capital, although foreign investor flows are highly sensitive to the geopolitical climate and will depend on economic and political stability.
Furthermore, higher term premiums in the US may support the dollar initially. However, over time, the combination of more expensive financing, portfolio diversification and the relative strength of Asian economies is likely to favour the appreciation of these currencies and of those of countries with credible fiscal outlooks and central banks committed to anti-inflationary discipline.
This reflects a broader structural reality: demand for capital is rising
The fact is that governments need to finance investment in infrastructure and defence, technological transformation and social spending, linked to an ageing population. At the same time, companies are entering a new cycle of capital investment to adapt to the world of agent-based AI. Faced with greater demand for capital, inflationary uncertainty, persistent public budget deficits and continued fiscal generosity, it is likely that investors will demand higher compensation for long-term lending.
Specifically, we expect the yield on the ten-year US Treasury bond to rise from 4.4 per cent in April 2026 to around 4.75 per cent by 2036, that of the German bond from 3.04 per cent to around 3.3 per cent and that of the Swiss bond to around 1.2 per cent.
Furthermore, structurally higher public debt is likely to compete with companies’ efforts to finance their investment needs. Gross debt issuance associated with the AI investment cycle of the hyperscalers could rise from $98,000 million in 2025 to around $200,000 million in 2026. So far, the financial markets have absorbed this increase in supply relatively well.
Companies have also turned to the private markets in search of bespoke financing solutions to support the AI investment cycle, with strong demand from investors, which has allowed for tight credit spreads relative to government debt, despite higher yields to maturity. However, over time, increased competition for capital may tighten corporate financing conditions, and the yield spread on investment-grade corporate debt in developed markets could rise by 1 per cent, whilst that on high-yield debt in the US and Europe could rise by slightly more than 3 per cent.
If the cost of capital continues to rise structurally, fixed income may become more attractive, with greater allocation to bonds and downward pressure on equity valuations. But we are not yet close to that turning point.
