AI Boom Pushes Bond Yields Higher As Neutral Rates Rise

The artificial intelligence investment boom and rising borrowing costs may appear contradictory at first glance. However, economists and investors increasingly believe the two trends are closely connected. Beyond the excitement surrounding AI spending, many analysts now argue that a long-term productivity surge is lifting estimates of neutral interest rates even as labour’s share of economic output continues to shrink.

Recent bond market volatility has partly reflected the inflationary shock linked to tensions involving Iran and the resulting rise in oil prices. Yet record highs in equity markets during an energy squeeze have puzzled many observers. Increasingly, attention has turned to the extraordinary scale of AI-related capital expenditure as a more convincing explanation for both rising stock prices and climbing bond yields.

Goldman Sachs estimates that AI investment could total $7.6 trillion over the next five years. Consequently, major financial institutions are reassessing how AI may reshape long-term economic growth, inflation and interest rates.

AI Investment Reshapes Interest Rate Expectations

A growing number of economists now believe that AI-driven productivity gains and heavy investment spending will increase the so-called neutral real interest rate, or R-star. This rate represents the level at which the economy operates in balance without overheating or slowing excessively.

Last week, the Institute of International Finance argued that a successful AI cycle should raise R-star because stronger expected returns and greater capital formation increase investment demand relative to savings.

As a result, markets may no longer return to the ultra-low real interest rate environment that defined much of the 2010s.

Barclays reached a similar conclusion in its latest Equity-Gilt Study. The bank argued that rising productivity combined with enormous capital expenditure requirements points towards structurally higher neutral real interest rates.

At the same time, inflation-adjusted policy rates in several economies remain negative even as AI investment accelerates. Therefore, some analysts believe central banks risk falling behind the curve in tightening monetary policy. Bond markets may already be adjusting to this possibility.

This trend also helps explain why AI-led stock indices such as the S&P 500 and Nasdaq continue to rise alongside long-term bond yields. Traditionally, higher yields pressure equities, but investors currently see AI-driven growth as powerful enough to offset those concerns.

Labour Share Faces Further Pressure

Another major debate centres on how AI and robotics may affect jobs, wages and income distribution. Economists remain divided on whether AI will mainly enhance human productivity or replace workers across broad sectors of the economy.

TS Lombard economist Dario Perkins argued this week that AI is more likely to augment jobs than eliminate them entirely. Nevertheless, he highlighted how the wage share of GDP has resumed its decline after a brief post-pandemic rebound.

Perkins also noted a close relationship between labour’s share of GDP and estimates of R-star. He argued that workers may eventually reclaim a larger share of economic gains through populist politics, fiscal activism and deglobalisation pressures.

However, current trends still point towards declining labour income shares. That may create political challenges, particularly for administrations that promised stronger wage growth and industrial revival.

Robotics And Energy Demand Add Inflation Risks

Barclays economists Christian Keller and Akash Utsav suggested that AI combined with humanoid robotics could intensify automation across many industries. Unlike earlier technological advances, AI-enhanced robotics may affect a much wider range of jobs and sectors.

Consequently, the distribution of national income could shift even further from labour towards capital owners. According to Barclays, this trend has already developed over recent decades and may accelerate as automation becomes more sophisticated.

Even if wage growth weakens, the economists believe AI infrastructure itself may sustain inflationary pressures. Massive demand for electricity, energy and raw materials needed to build and maintain AI systems could increase long-term costs across the economy.

That outlook leaves bond investors hoping for slower economic growth or recession to cool inflation pressures. However, many investors still see a downturn as unlikely because of the ongoing AI-driven expansion.

Bank of America’s latest global asset manager survey showed that only 4% of respondents expect a hard economic landing. Meanwhile, more than 60% believe the 30-year U.S. Treasury yield could rise above 6% within the next year, reflecting continued confidence that the AI boom still has room to grow.

With inputs from Reuters