U.S. economy defies 5% bond yields as consumer spending and business activity surge

The U.S. economy keeps expanding while borrowing costs are rallying in a way that seems completely out of control.

The rates for US Treasuries rose once again on Friday. The 10-year rate hit 5.230% at one point during the day, its highest level since June 2007. The 30-year rate moved above 5.51%, which is a level it had not been at since 2004.

Meanwhile, shorter-duration bonds followed suit with the 2-year Treasury rate moving towards 4.90%. Such levels would normally prompt thoughts of weak demand.

This is not the case, with higher consumption, business activity, manufacturing performance, and large investments in AI.

The argument on Wall Street is now about why yields are rising so fast. Inflation remains one possible driver. Stronger economic output is another. Washington’s growing borrowing needs are also getting plenty of attention as federal deficits expand.

Investors are nervous because each explanation points toward rates staying elevated. Stocks have still resisted the pressure. The S&P 500 remains near record highs in September, while growth-focused shares have performed better than many cyclical areas.

That strength comes as markets approach a quarter that has historically produced some of the strongest equity returns of the year, although stretched prices and the approaching U.S. midterm election season are adding another layer of risk.

Fresh business readings push growth back into the bond market debate

Economic figures released Wednesday gave the growth camp fresh ammunition. A closely watched business survey from S&P Global (NYSE: SPGI) recorded a sharp improvement across U.S. companies. Its manufacturing measure posted its largest monthly advance since 2022. Services moved even faster, reaching their strongest level since 2021, with new orders helping drive the increase.

The report usually receives less attention than major inflation or employment releases. This time, traders noticed. Bond selling accelerated as investors considered whether the economy may be gathering speed rather than cooling.

Ed Yardeni, chief investment strategist at Yardeni Research, said, “The main reason that bond yields rose sharply is that the US economy is booming.”

That view has also shaped trading inside the stock market. If rates are climbing because businesses and households are producing more demand rather than because inflation is breaking loose again, some investors see large technology companies as better positioned than economically sensitive sectors.

AI spending is part of that calculation. Tens of billions of dollars are moving into chips, computing infrastructure, data centers and other AI-related projects. That investment has kept growth-oriented shares in focus even as government borrowing costs rise.

Consumers keep opening their wallets while Fed officials track stronger demand

Household consumption has been one of the most obvious factors explaining why the economy managed not to slow down much. Indeed, real consumer spending picked up to 3.4% in annualized terms in Q2 despite the fact that this metric started the year showing some weakness. Estimates suggest that consumption will continue growing in Q3. According to the GDPNow model of the Atlanta Federal Reserve, consumer spending growth will be close to 4%.

Philadelphia Federal Reserve President Anna Paulson noted recently that economic conditions have stayed strong amid tariff pressures and rising oil prices. Anna mentioned consumer demand, solid employment and big cycle of AI investments as the main elements of the current situation. In addition, she believes that rising share prices will provide additional impetus to household consumption.

Cleveland Federal Reserve President Beth Hammack made a similar point during a Friday panel in Cleveland. Beth said several forces are affecting Treasury yields, but stronger economic performance belongs on that list.

“I think that the growth numbers have come in in a pretty solid way,” Beth said. “I think that expectations of continued performance, if you look at earnings and profits for various public companies, they’ve been coming in above expectations, and there have been signs of resilience that I think the markets are starting to price in.”

According to Beth, the labor market is still near her definition of maximum employment. Furthermore, she also noted that the market reflects increasing traders’ anticipation of further Federal Reserve interest rate hikes. Nevertheless, she mentioned that the fiscal policy of the federal government is unsustainable.

Consumers have repeatedly surprised policymakers by refusing to retreat as much as expected.

“We’ve been expecting the consumer to step back for quite a number of years, and they really haven’t,” Beth said. “They’ve continued to spend, and that’s been fueling the economy.”

Deficit concerns are certainly not forgotten. Wil Stith, who is the senior bond portfolio manager for Wilmington Trust, attaches more importance to politics in Washington than to the recent figures of economic growth.

While acknowledging that economic growth has contributed to upward pressure on the Treasury rates, his more serious concern is on the government’s side. He attributed the rise in yields to excessive government spending and the budget deficit.