The market bloodbath just exposed Wall Street’s true fears about U.S. debt, top economist warns

There have been competing theories to explain why Treasury yields have risen so much this year, but last week's brutal stock selloff debunked one of them, according to a top economist.

The 10-year yield has eased in recent weeks as investors seek shelter in Treasuries. But before the latest dip, it shot up more 100 basis points, soaring above 5% and at one point hitting the highest level in 24 years.

The run-up began after the Iran war started in late February, sending oil prices up and raising expectations that the Federal Reserve will hike rates to fight suddenly resurgent inflation.

At the same time, hyperscalers have been flooding the bond market with fresh debt to finance massive capital spending and the AI infrastructure boom, which has kept the U.S. economy running hot and inflation sticky.

That's competed for investors' dollars as the Treasury Department taps the bond market to finance the federal government's $2 trillion budget deficit—and pay interest of the $40 trillion in U.S. debt.

Some on Wall Street have downplayed the spike in yields, saying the deluge of AI debt has crowded out U.S. bonds and forced the Treasury to offer investors higher returns at auctions.

But Robin Brooks, a senior fellow at the Brookings Institution, doesn't buy that explanation. In a Substack post on Saturday , he said the past week's market selloff represented a "natural experiment" that puts the competing arguments to the test.

"On one end of the spectrum are people like me who think this is a rising fiscal risk premium as our public debt grows out of control," he wrote. "On the other end are folks who say it's hyperscaler debt issuance that's pushing up yields, so there's no sign fiscal policy's in trouble."

Brooks said corporate borrowing is nowhere near where it was in the IT bubble of the early 2000s, while public borrowing is historically high and more likely driving up yields.

He pointed to the bond market's reaction to the latest monthly jobs report, which showed payrolls grew by more than double the consensus estimate.

Compared to previous upside job surprises, the two-year yield rose more than what hot economic growth could explain, undercutting the idea that U.S. growth depends on AI as well as the argument that AI is responsible for higher yields.

Brooks also cited the market-implied yield for a 10-year security 10 years from now, which gauges the premium investors demand for the risk of holding Treasuries long term. Such risks include the trajectory of U.S. debt and deficits.