Why is the US bond market under pressure? Japan, Fed rates, AI borrowing and $40T debt explained

Why is the US bond market under pressure? Japan bond yields, Fed rates, AI borrowing and $40 trillion US debt are pushing Treasury yields higher.

The US bond market is under pressure again, with long-term Treasury yields near multi-decade highs. Higher yields are making mortgages and corporate loans more expensive and can also hurt stock valuations. The pressure is especially visible in the 30-year Treasury yield. The yield has moved back toward its highest level since 2007, even after US Treasury Secretary Scott Bessent doubled the size of long-term Treasury buybacks last month.

US Treasury bonds face pressure as yields rise amid Japan rates, AI borrowing and growing US debt. (Pexel)

Washington is now watching Japan closely because Japan is one of the biggest foreign buyers of US government debt. Japan holds about $1.1 trillion in US Treasurys, making it an important source of demand for US government bonds, according to Yahoo Finance. Japan's own bond market is changing rapidly. For years, Japanese interest rates were close to zero, pushing Japanese investors to look overseas for better returns.

Japan bond yields are rising

That situation has now changed. Japan's 10-year government bond yield is around 3%, its highest level since 1996. Higher Japanese bond yields could make Japanese investors less interested in US Treasurys. If investors can earn better returns at home, they have less reason to move their money into US or other foreign bonds.

FIMA could protect US Treasurys

An obscure Federal Reserve facility could help Japan avoid selling Treasurys during a currency intervention. The facility is called the FIMA repo facility. FIMA allows foreign central banks to temporarily exchange US Treasurys for dollars from the Federal Reserve. This means Japan can get the dollars it needs without immediately selling its Treasurys into the open market, according to the Federal Reserve.

Bessent has also asked the Federal Reserve to consider making FIMA bigger. His request shows that Washington is preparing for currency pressure from Japan to potentially last longer than one intervention, according to Reuters.

He argued that the facility can help prevent a weak yen from forcing Japan to sell US Treasurys, according to CNBC. But FIMA cannot solve the bigger problem for US bonds. It can stop forced Treasury sales during currency intervention, but it cannot make a US Treasury bond more attractive to a Japanese investor who can earn around 3% by investing at home.

R-star may keep rates high

That is why Washington wants to prevent problems in Japan from spilling into the US bond market. Another major issue is a complicated economic concept called R-star, which could help explain why US interest rates may remain high.

R-star is the estimated interest rate that neither boosts nor slows the economy. In simple terms, it is the level at which monetary policy is considered neutral. Economists use different models and time periods to calculate it, making the measure difficult to estimate, according to Reuters.

The New York Fed's latest estimate puts R-star at 1.65% for the second quarter of 2026. Some investors now believe the true neutral rate could be higher than the latest estimate. They point to two major forces: huge investment in artificial intelligence and heavy US government borrowing.

AI is raising demand for money

AI is creating enormous demand for money. Big technology companies are spending heavily to build data centres, computing systems and other infrastructure needed for the AI boom. The biggest cloud companies are also raising large amounts of money through the bond market. Companies such as Amazon, Microsoft and Google's parent Alphabet are among the major hyperscalers involved in the AI investment boom, according to Reuters.

This creates more competition for investor money. AI companies are selling bonds at the same time the US government is selling large amounts of Treasury debt. When more borrowers compete for the same pool of capital, borrowing costs can rise. Investors may demand higher interest rates before they are willing to lend money for long periods.

Fed rate cuts face a problem

That can push Treasury yields higher as well. Truist Wealth's Chip Hughey said heavy AI investment and higher government debt could increase demand for capital and lift real interest rates. A higher R-star could mean interest rates stay higher for longer. If the economy needs a higher neutral rate, the Federal Reserve may eventually need to keep its policy rate at a higher level than investors currently expect, according to Reuters.

That creates a problem for investors waiting for Fed rate cuts. If the neutral rate has structurally moved higher, the Fed may have less room to cut rates back toward the very low levels seen in the past.

10-year and 30-year yields face pressure

The 10-year Treasury yield faces two pressures. Investors may expect higher future interest rates, while they may also demand a larger term premium for holding long-term government debt. The term premium is basically extra compensation investors want for taking the risk of holding a bond for a long time. When uncertainty around inflation, borrowing and interest rates increases, investors can demand more of this extra return.

The 30-year Treasury is particularly vulnerable. CreditSights' Zachary Griffiths said the effect of a higher R-star is historically stronger at the long end of the curve because the US has high debt levels and large, persistent budget deficits. The AI boom is therefore creating a strange situation for the bond market. The private sector is borrowing heavily to fund AI investment while the US government is also borrowing heavily.

US debt crosses $40 trillion

This creates a huge combined demand for capital. Both technology companies and the US government are competing for money from investors, which can keep longer-term borrowing costs elevated. UBS's Ulrike Hoffmann-Burchardi said the Federal Reserve may not be able to easily cut rates back to zero. She pointed to the continued structural demand for capital created by the AI investment boom, according to Reuters.

Meanwhile, the US government's borrowing problem is getting bigger. The US national debt has now crossed the $40 trillion mark. The $40 trillion debt level adds another source of demand for capital. The government needs to keep issuing debt to finance its spending and deficits, increasing the supply of Treasury bonds that investors must absorb.

This creates an unusual combination for financial markets. The US government has a huge need to borrow at the same time that private companies are making a massive investment push into AI. That combination could keep the neutral interest rate higher. Even if the Federal Reserve pauses its rate moves, strong demand for capital from both the government and businesses could continue putting pressure on borrowing costs, according to Reuters.

Why higher yields matter

For ordinary Americans, the bond-market pressure can eventually show up in everyday borrowing costs. Higher long-term Treasury yields can push up mortgage rates and corporate borrowing costs. It can also affect the stock market. When Treasury yields rise, safer government bonds can become more attractive relative to stocks, while higher borrowing costs can also reduce the value investors place on future corporate earnings.

The Federal Reserve is therefore facing a difficult balancing act. So, the US bond-market pressure is not being caused by one single issue. Japan's higher interest rates, possible Japanese Treasury sales, an uncertain neutral rate, massive AI investment, heavy government borrowing and the $40 trillion national debt are all adding to the pressure.