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• The economist also said that the recent large increase in interest rates is a consequence of soaring demand for credit both to build data centers and to cover federal deficits
• On Tuesday, the U.S. 30-year Treasury yield climbed to a fresh 19-year high, climbing over 5.33%, while U.S. 10-year Treasury yields also rose above 4.7%, hitting multi-month highs. 
• On Wednesday, the U.S. Treasury Department revealed that public debt has now surpassed $40 trillion.

The 30-year Treasury yield briefly topped 5.33% on Tuesday as U.S. government debt crossed $40 trillion, raising fresh concerns about the bond market. And while long-term interest rates worldwide have reached levels not seen since the mid-2000s, Nobel Prize-winning economist Paul Krugman says investors should not panic.

“Interest rates are up, but this is not a debt crisis,” he said in a post on his Substack. 

In a post published on Wednesday, Krugman said the latest rise in long-term interest rates is being mainly driven by soaring demand for credit, especially from the artificial intelligence (AI) infrastructure boom and large federal budget deficits.

Why Are Interest Rates Rising?

On Tuesday, the U.S. 30-year Treasury yield climbed to a fresh 19-year high, climbing over 5.33%, while U.S. 10-year Treasury yields also rose above 4.7%, hitting multi-month highs. 

Meanwhile, Japan’s 10-year bond yield also jumped to its highest level in 30 years, Germany’s 30-year Bund yields climbed to their highest level since 2011, and France’s 30-year bond yields hit levels last seen in 2008.

Krugman attributed the rise in interest rates across the world to two factors: stronger demand for credit than available supply, and higher risk premiums demanded by investors. 

The economist said that in the current environment, the first factor matters more, with heavy borrowing for AI infrastructure and large U.S. budget deficits driving demand for funds. 

Krugman argued that in today’s economy, demand for credit from the AI boom appears to be bigger, even relative to the economy, than the IT boom of the 1990s. 

This is largely a consequence “revealed by the dramatic deterioration of the cash flow position of ‘hyperscalers,’” he said, adding that their extreme spending is forcing them to sell bonds to finance their AI expenditures.

Meanwhile, he also added that due to Trump’s large tax cuts, the government deficit is “huge.” On Wednesday, the U.S. Treasury department revealed that public debt has now surpassed $40 trillion.

Why Krugman Believes There’s No Need To Panic

Despite the growing debt levels and rising interest rates, Krugman said that there is no need to panic because the rise in interest rates does not signal an imminent U.S. debt crisis. 

The U.S. borrows in its own currency, making a Greece-style crisis unlikely, while measures of inflation expectations and U.S. default risk have remained relatively stable. 

“So the recent large increase in interest rates is a consequence of soaring demand for credit both to build datacenters and to cover federal deficits,” he said, adding that there were no fears about U.S. solvency.

How Are Bond Yields Reacting Now?

U.S. long-term bond yields have cooled late Wednesday after the Treasury Department announced that it would at least double government debt buybacks, expected to go into effect Sept. 9. The surprise move marks a sharp change from the tentative buyback schedule announced just two weeks earlier.

Jeremy Stretch, head of G10 FX Strategy at CIBC, told Reuters that the Treasury’s buyback move signals it recognizes the pressure in the bond market and is willing to adjust policy to help ease those strains.

The U.S. 30-year Treasury yield fell to 5.186% at the time of writing, while U.S. 10-year Treasury yield was at 4.641%. 

The iShares Core 10+ Year USD Bond ETF (ILTB) was down 0.05% at the time of writing amid ‘neutral’ sentiment. The iShares 20+ Year Treasury Bond ETF (TLT) was up marginally by 0.02% at the time of writing amid ‘bullish’ sentiment. 

Meanwhile, among ETFs tracking benchmark indexes, the SPDR S&P 500 ETF (SPY), which tracks the S&P 500, was up 0.13% overnight amid ‘neutral’ sentiment. The Invesco QQQ Trust (QQQ) and the SPDR Dow Jones Industrial Average ETF Trust (DIA) were up 0.35% and 0.04% respectively at the time of writing amid ‘neutral’ and ‘bearish’ sentiment. 

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