Daiwa: Possibility of High Long-term U.S. Treasury Yields Becoming Structural... Supply and Demand Improvement Remains Elusive

Daiwa Institute of Research has projected that the long-term and ultra-long-term U.S. Treasury yields will remain structurally high. It diagnosed that it is currently difficult to find scenarios on the demand side that could lower interest rates.

In a report on the long-term and ultra-long-term U.S. Treasury yields released on the 4th, the institute stated that even if there are changes in demand, there is a high likelihood that negative situations in the financial markets and real economy, such as a sharp drop in stock prices or increased credit risk, will accompany it.

The first factor identified by the institute is the investment in artificial intelligence (AI) by hyperscalers. While the possibility of unilateral expansion of hyperscaler investments has decreased, it also believes that the scale of investment is unlikely to decrease sharply in a phase where the use of AI is increasing. It explained that the competition between U.S. Treasuries and long-term bonds issued by hyperscalers continues, leaving little room for supply and demand improvement.

Hyperscalers refer to large technology companies that operate massive cloud and data center infrastructures. To expand AI data centers, they need to invest large amounts of capital not only in construction costs but also in power, cooling, and communication facilities, resulting in a large scale of bond issuance. This creates a structure where long-term bonds from hyperscalers share investor funds with U.S. Treasuries in the same maturity range.

The institute believes that if hyperscalers shift towards equity issuance such as IPOs or capital increases instead of corporate bonds, the relative attractiveness of Treasuries could increase. However, it pointed out that this could lead to increased risks in the financial markets and the real economy due to falling stock prices and rising credit risks, which is undesirable. This means that the very path to lowering Treasury yields could accompany other side effects.

BlackRock has also previously diagnosed that the capital competition between governments and AI companies could exert additional upward pressure on long-term government bond yields in developed countries. Wei Li, BlackRock's Global Chief Strategist, and Vivek Paul, Head of Global Portfolio Research, commented at the time that "governments, AI hyperscalers, and companies across the economy are competing more fiercely than ever for capital," adding that "this maintains upward pressure on long-term government bond yields even in scenarios of an AI productivity boom." This suggests that if the demand for funds increases alongside rising growth rates, the decline in long-term interest rates could be limited, aligning with the diagnosis and direction of Daiwa Institute of Research.

The second factor is the avoidance of U.S. Treasury purchases by foreign central banks and pension funds. The institute believes that the U.S. government's economic sanctions against Iran could act as a factor suppressing the holding of dollar-denominated assets.

If the atmosphere of diversifying foreign currency reserves rapidly shrinks, prices of risk assets such as stocks could plummet, leading to a "dollar buy in emergencies," but this is also not a desirable direction for the global economy and financial markets. The U.S. itself could become a source of market uncertainty, which may not be favorable for lowering Treasury yields.

The third factor is the U.S. midterm elections. The institute pointed out that to alleviate the current high interest rate situation, significant fiscal improvements that can offset the effects of rising interest rates are needed, rather than temporary measures like buybacks. The likelihood of reducing fiscal expenditures, such as curbing social security costs, is low ahead of the midterm elections.

The institute predicts that if President Donald Trump pulls out the tariff card again and steers policies in a direction that stimulates inflation, the need for tightening by the Federal Reserve (Fed) could only increase. In a situation where there is little room for fiscal easing, the burden of monetary policy could further reduce the cards available to lower long-term interest rates.

The institute stated that improving the Middle Eastern situation to suppress energy prices and additional expansion of defense spending could help prevent the deterioration of fiscal balance, thereby lowering long-term and ultra-long-term Treasury yields. Unlike the three negative factors, this aspect was presented as a variable that supports a decline in interest rates.

The possibility of long-term interest rates becoming stuck at a high level is closely related to the liquidity environment of risk assets overall. Bitcoin (BTC) and Ethereum (ETH) often move more sensitively to interest rate expectations and dollar liquidity than to individual materials, making this diagnosis a point of reference for participants in the domestic crypto market. The warning from a Federal Reserve official that if AI investment precedes productivity improvement, inflationary pressures may remain has also been previously reported.

Ultimately, whether long-term interest rates become stuck will depend on the direction of fiscal policy after the U.S. midterm elections, the flow of the Middle Eastern situation, and changes in the funding methods of hyperscalers.

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