AI could first push yields higher, then lower

The US 10-year Treasury yield could increase from its present level of around 5% towards 6% next year because of the AI investment boom.

But what could happen after that?

A new report by Allianz argues that although AI could push interest rates higher at first, it could eventually push them lower.

If AI makes workers and companies more productive, the economy should be able to grow faster. Faster growth creates more investment opportunities, increasing companies' demand for capital.

When more businesses want to borrow and invest, the equilibrium interest rate needed to balance saving and investment rises.

Allianz estimates that this effect could increase the neutral interest rate in the US by as much as 0.7 percentage points over the coming decade.

But this is not the whole story.

Higher productivity and economic growth also increase government tax revenues. Government spending, meanwhile, does not necessarily increase at the same pace.

If AI improves the US government's finances, investors may become more comfortable holding Treasury bonds and demand less additional compensation for fiscal risk.

Allianz estimates that this fiscal effect could eventually lower the US 10-year Treasury yield by around 0.9 percentage points.

Overall, Allianz calculates that AI could initially push the US 10-year yield almost 0.9 percentage points higher, with the impact peaking around 2032. But by 2036, the effect reverses: AI could leave the 10-year yield around 0.5 percentage points lower than it otherwise would have been.

In other words, AI could first push yields higher, and later pull them lower.

In the next few years, enormous investment in data centres, electricity generation, chips and other infrastructure could contribute to keeping bond yields unusually high.

But if those investments eventually deliver the productivity gains that justify them, the longer-term consequence could be exactly the opposite: stronger growth, healthier government finances and lower long-term bond yields.

So a move towards 6% in the US 10-year yield would not necessarily mean that 6% is the new long-term normal. The more successful the AI boom ultimately becomes, the stronger the forces pushing yields back down could eventually be.