When the 30-year US Treasury yield briefly surged past 5.3%, it triggered sharp pullbacks in AI-related equities worldwide and intensified volatility across global markets. The prevailing market narrative has cast rising long-end Treasury yields as the primary source of risk, but we hold a contrarian view: the yield spike may be a symptom rather than the cause, with the real driver of the sell-off lying elsewhere.
US Treasury Fundamentals Are Improving, Not Deteriorating
From an economic perspective, recent US data across inflation, employment, and consumption all point to cooling rather than acceleration. July CPI rose only 0.1% month-over-month, with the annual rate easing from 3.5% to 3.4%, while core CPI dipped from 2.6% to 2.5%. Non-farm payrolls contracted by 23,000 in July, with cumulative downward revisions of 103,000 for May and June. Retail sales fell 0.6% month-over-month in July, the steepest single-month decline since May 2025 and far below the consensus forecast of 0.1% growth. Although oil prices have rebounded recently, this oil shock lacks the "second-round effects" on inflation, and with midterm elections approaching, the likelihood of Trump's TACO policy increases, limiting oil's impact on inflation and rates.
On the supply-demand front, while the US deficit ratio has ticked up recently, this has been driven primarily by short-dated debt issuance, which does not affect long-end yields. The modest increase in August long-bond auction volumes reflects seasonal refunding patterns, with September expected to see a downward adjustment. The long end has not experienced a supply shock this month. As for the US debt stock crossing $40 trillion, this is a widely anticipated long-term trend with limited relevance to near-term market moves.
On liquidity, the Federal Reserve continues to slowly expand its balance sheet, with total assets up approximately $120 billion since end-2025 and bank reserves up about $94 billion. The July FOMC meeting delivered no hike and instead signaled a dovish stance, improving liquidity expectations. Despite increased short-dated Treasury issuance, ample dollar liquidity has kept markets functioning smoothly, as evidenced by falling short-end yields, a weaker dollar, and stable money market spreads.
Taken together, the fundamental backdrop for Treasuries argues for lower rather than higher yields. The fact that long-end rates spiked anyway suggests other significant market forces are at work.
AI Bond Supply Surge Creates Liquidity Mismatch, the True Risk Source
The real culprit behind the global asset sell-off may be a liquidity mismatch in the long-duration bond market. US investment-grade corporate bond issuance reached approximately $1.7 trillion through August, a record high for the period. We project that 2026 net corporate bond supply could exceed that of US coupon-bearing Treasuries. As AI capital expenditures expand and payback periods lengthen, tech giants have significantly increased demand for long-duration debt financing, with issuance of bonds with tenors of 10 years or more rising. This has tightened supply-demand dynamics in the long-end bond market.
In the primary market, order book coverage for new AI hyperscaler bonds has fallen from near 5x at the start of the year to under 2x recently, indicating diminishing marginal appetite for new supply. Issuers must now offer higher yields and wider credit spreads to attract capital. This primary market pressure has transmitted to secondary markets, with long-duration tech bond credit spreads and CDS spreads widening accordingly.
Given limited trading depth in some tech CDS, thinner market liquidity amplifies price swings. Long-duration AI bonds and long-end Treasuries are essentially competing for the same pool of duration capital from insurers and pension funds. When new corporate bonds offer higher yields, some investors sell Treasuries to buy AI debt. Even without a sudden increase in Treasury long-end supply, the expansion of overall market duration supply can push term premia higher, driving long-end Treasury yields up passively. In this sense, Treasuries are more victims than perpetrators of this shock. The high profile of the Treasury market amplifies panic when yields spike, creating negative feedback loops that push AI stocks lower.
It is worth noting that despite the significant widening in AI bond credit spreads and CDS, the credit profiles of leading AI companies remain relatively healthy. We see limited credit risk and no systemic liquidity problems. This round of bond market adjustment resembles a localized liquidity mismatch in the long-duration segment, forming negative feedback against a backdrop of wavering AI narratives. The AI revolution is no longer just a stock market story; it is now reshaping the bond market, and we advise closer attention to AI bond supply dynamics.
Policy Response: Treasury Buybacks Offer Palliative Relief, Fed Hike Risks Diminish
In response to the structural liquidity mismatch, the US Treasury has begun proactively easing pressure on long-end bonds. On August 19, the Treasury announced it would raise the per-auction liquidity support buyback cap for 10-20 year and 20-30 year maturities from $2 billion to at least $4 billion. These buybacks are neither QE nor yield curve control (YCC): they set no yield targets, and because the funding comes from issuing short-dated debt rather than expanding the Fed's balance sheet, they do not constitute QE. The buybacks directly add bid support for long-end Treasuries, improving liquidity conditions through active intervention.
The Treasury market has long prided itself on free trading and market-based pricing. Yet the early-August coordinated intervention with Japan to prevent yen-driven Treasury selling, followed by this surprise buyback announcement, marks a notable increase in direct government involvement. Without policies to reduce the fiscal deficit or address the surge in AI bond supply and the shortage of marginal Treasury buyers, such interventions may paradoxically undermine confidence in Treasuries and the dollar, adding uncertainty and pushing term premia higher.
Because rising long-end yields have already tightened financial conditions, restraining growth and market performance, they have effectively done the Fed's tightening work for it. This reduces the necessity of further rate hikes and increases the likelihood of eventual cuts.
Asset Allocation: Overweight Gold, Accumulate Tech on Dips, Neutral on Treasuries, Favor Curve Steepening
The Treasury's buyback announcement has a dual effect: it adds long-end buying support and improves liquidity, but it also weakens confidence in Treasuries and the dollar. Gold is the most direct beneficiary, while the dollar is the clearest loser. We maintain our overweight recommendation on gold and expect continued dollar depreciation. Following the buyback news, gold and bitcoin rallied notably, while China-US tech stocks saw only limited rebounds, confirming that Treasury buybacks are palliative rather than curative. They can ease financial conditions but cannot immediately resolve concerns about excessive AI capex and rising debt issuance. Tech stocks will likely need to rely on AI industry trends and earnings delivery to regain support.
Given that the AI revolution remains in its early stages, with real demand indicators like token usage still growing rapidly and industry trends intact, valuations have also become more reasonable after the July sell-off. We believe AI stocks may simply be taking a pause relative to gold's rally. We continue to favor Chinese and US tech equities and recommend accumulating on dips.
For Treasuries, rather than betting on a one-way decline in long-end yields, we see curve steepening as the more confident trade. Long-end rates have retreated somewhat following the buyback announcement, but the underlying issues remain unresolved. September marks the peak season for credit bond issuance, adding uncertainty to the long-end market. We adopt a more neutral stance on Treasuries and are in no hurry to position for a downward rate trend. With long-end yields having already tightened financial conditions, the case for further Fed hikes has weakened, and renewed rate cut expectations should push short-end yields lower, likely steepening the yield curve.
Key risks include a slowdown in AI vendor expansion and potential improvement in the US deficit situation.
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