Repricing the Cost of Capital
Overview:
Global bond yields have surged to their highest levels in years. The U.S. 30-year is trading at 5.34%, a level last seen in mid-2007. At 4.93%, the U.S. 10-year is inching closer to the psychologically important 5.0% level. Germany's 10-year is back to where it sat during the peak of the European debt crisis, U.K. gilts are at post-2008 highs, and Japan touched 3% for the first time in three decades. When four sovereign markets with different central banks, politics, demographic trends, and economic drivers move together, something global is at work.
Three primary forces are driving this, and in our view, they are structural as opposed to cyclical. First, bond supply has exploded, with Washington financing the fiscal deficit and corporate America financing the AI buildout. Second, inflation is not cooperating, and the energy supply shock lacks near-term resolution. Third, due to inflation and the resilience of the economy, the Fed is no longer debating cuts but rather the timing of a hike. As a result, investors are now demanding more compensation to own long-term bonds. The cost of capital is repricing, and the implications go well beyond fixed income.
Below, we elaborate on why this is happening, why it’s unlikely to reverse quickly, and how we are positioning client portfolios around these powerful forces.
Diversify’s Take:
Bond Supply vs. Demand
The U.S. federal debt crossed $40 trillion in August, the fiscal deficit is tracking ~$2 trillion, and the interest expense on that debt now runs over $1 trillion annually. Alongside this surging global sovereign supply sits corporate issuance unlike anything we have seen in years.
Investment grade supply is on track to clear $2.2 trillion for the first time. Companies once described as “asset light”, generating enough free cash flow to fund their operations and repurchase shares, are now financing capital expenditure that will collectively exceed $1 trillion this year. Net borrowing by these large technology firms is tracking toward ~$200 billion, about a quarter of the U.S. Treasury’s issuance. Alphabet recently issued 30-year paper at 6.4%, and Meta’s data center debt now yields above 7.5%. Washington and the AI buildout are competing for the same lenders. When investors can own investment grade corporate debt at those levels, Treasury has to pay more to attract the same capital.
Unless that supply is met with a commensurate increase in demand, yields rise to clear the market. Treasury Secretary Bessent tried to address the demand side directly on August 19th by at least doubling the size of long-dated Treasury buybacks from $2 billion to $4 billion per issue. The 10-year closed down 6bps that day and the 30-year fell 9bps to 5.20%. But within 24 hours, both had erased the move and yields now trade meaningfully higher than before the announcement. In our view, this type of intervention does not address the structural problem, and it may do more harm than good in terms of lost credibility.
The Inflation Picture Isn't Improving
The path to tame inflation appears to be getting longer. July's year-over-year core PCE stands at 3.3%, and August's level will likely be higher. Those pressures are also broadening.
Energy is the most immediate. The enduring war with Iran and the resulting supply shock have again driven Brent to $107/barrel, WTI to $101/barrel, and gas at the pump to $4.28/gallon.¹ Those prices reintroduce the risk of pass-through to the broader economy via transportation and input costs. We have a hard time identifying clear resolution in the Middle East near term, which increases the risk this shock lingers. Beyond energy, services inflation never fully normalized, and a national housing shortage means shelter inflation is not rolling over. Trade wars remain prone to flare-ups, most recently with Canada. And the newest entrant on the 2026 bingo card is the AI-induced “chip-flation”, which is reaching consumer electronics and autos.
None of this points to runaway inflation, and the bond market is not signaling anything so drastic. Treasuries today are pricing inflation to settle near 2.3% over the next decade. What has changed is what investors insist on earning above inflation, and a 10-year Treasury now pays a real yield of close to 2.5%. Inflation does not have to spiral for yields to stay elevated. It only has to stay unresolved, and that is our base case.
The Fed's Conundrum
The Fed entered 2026 expecting to cut several times this year and is now debating the timing of a hike. Inflation is running near 3.5% against the Fed’s 2.0% target, and it has been above that target for more than five straight years. Holding rates steady while inflation runs above 3% risks the credibility that anchors the long end of the curve. Hiking into a labor market that is solid but not robust risks denting the growth side of the equation.
This tension has been building for months. The FOMC has kept the policy rate at 3.50-3.75% for five straight meetings, but July had three dissents in favor of a hike. New Chair Warsh has called letting inflation run hot a choice, and his Jackson Hole message was direct: if underlying inflation does not improve, the Fed has “work to do.” In those remarks, Warsh reinforced 2.0% PCE as a firm target. Last week's strong jobs report removed the easy excuse of another pause. Payrolls came in at 162k vs. consensus of 53k, with another 55k in upward revisions, and unemployment held steady at 4.1%. Fed funds futures have now moved to roughly 70% odds of a 25bps hike on September 16, up from 35% before the jobs report.²
But this is not the kind of inflation that rate policy addresses well. Today's pressures mostly come from supply shocks and policy decisions rather than an overheating economy. Wages are growing near 3%, slightly slower than inflation. Raising rates does not produce more oil or repeal tariffs. From a timing standpoint, this week's CPI print will likely decide the September meeting. If the Fed holds, a move in October immediately before the midterm elections seems unlikely, which would then push the decision to December.
Our read is that Warsh's tough talk is aimed more at the rate market than at the economy. If the FOMC moves this year, we expect one 25bps hike with the path left broadly unchanged. This would be a “credibility hike” as opposed to the start of a tightening cycle. However, if Warsh talks tough on inflation and then does nothing about it, that would erode his credibility, which could further punish the long end. Warsh is also steering the committee to become less communicative, and he’d prefer to remove forward guidance. We think rate volatility will stay elevated, and long-term yields may remain unanchored longer than the market expects.
Investment Implications:
Fixed Income
For bond investors, higher yields are painful to arrive at but wonderful to own. The starting yield explains the majority of forward bond returns, and starting yields today are generally the best they have been in two decades. Broad fixed income markets have returned 0%-3% YTD, and long-dated Treasuries are down 7%.
We expect long-end yields to keep rising on inflation and deficit concerns. We continue to favor the front and intermediate curve, where investors capture most of the available yield without incurring the incremental rate risk for which they are not being compensated. Implementation matters as much as the positioning. For sidelined cash, T-bill ladders are more attractive than money market funds net of state taxes and fees. For clients with defined liabilities, individual laddered bonds continue to make more sense than commingled funds, because they let us lock in a compelling after-inflation yield against known spending needs.
Credit spreads sit near the tightest levels in a generation, so we are not stretching for yield. Surging AI-related debt issuance is quietly changing the composition of the investment grade index, concentrating a supposedly diversifying asset class in a handful of technology balance sheets. Passive bond investors may own more of the AI trade than they realize.
Equity
Stocks have generally shrugged off higher rates, mostly on the strength of eye-popping earnings growth, including +50% in 2Q. As a result, broad-based valuations have compressed since the beginning of the year. We are closely watching the trajectory of earnings growth from here.
Higher rates work on equity prices through the discount rate. A higher risk-free rate falls hardest on companies whose value sits far in the future, so the most scrutiny lands on businesses with negative or minimal current earnings and those priced for perfection. The AI capital expenditure buildout has been financed on the assumption that capital stays abundant and cheap, and rising rates may test that assumption.
Investors are watching the 10-year as it bumps up against 5.0%. We have only approached that level twice in the past two decades, most recently in October 2023 and before that in June 2007. But in the 1990s, a period increasingly used as a comparison to today's environment, the 10-year routinely exceeded 5%. Then, as now, yields were high in part because economic growth was resilient. Our read is that the level itself is not the trigger. The speed with which yields get there matters at least as much. A rapid move through 5% would be far more disruptive than a gradual one.
This argues for heightened discipline rather than broad de-risking. We favor companies with durable competitive advantages, strong returns on capital, and real current earnings. As a reminder, equities also remain the single best asset class for fighting inflation over time. Our portfolio construction preferences hold: a balanced approach to growth and value, with market cap and geographic diversification well represented.
Alternative Investments
Private credit is where the rate environment is most directly felt. Floating rate structures continue to benefit from higher base rates, and all-in yields remain compelling relative to what public credit offers. But higher base rates that lift investor yields also raise debt service levels for borrowers, and that pressure compounds the longer rates stay elevated. Much of the same AI buildout showing up in the investment grade index is also being financed privately, particularly data center and power infrastructure lending, which means investors can end up with exposure to the same theme on both sides of their portfolio.
That makes credit underwriting considerably more important than it was three years ago. The asset class has grown substantially without being tested by a broad default cycle, and dispersion between managers is likely to widen when one arrives. We seek managers who have underwritten through prior cycles and who pass when pricing doesn’t compensate for the risk.
Real assets with contractual inflation escalators, including infrastructure and select real estate sectors, offer a more direct inflation hedge than most portfolios currently hold. However, higher discount rates also pressure valuations in these private markets, so escalators and rent growth must be durable. And in an environment where both rates and volatility are elevated, structured notes are increasingly attractive for their ability to create a defined outcome, including potential downside protection.
Summary:
The repricing in global bond markets looks structural to us. Supply is heavy from both Washington and corporate America, inflation is unresolved, and the Fed has an uncomfortable decision ahead. It’s likely these forces won’t fade away quickly, and the Treasury's attempt to intervene in August lasted less than a day.
But a repricing is not a breakdown. Investors still expect inflation to settle near 2.3% over the next decade, and equities have absorbed the move based on the strength of earnings. What has changed is the price of capital. Higher yields are painful to arrive at but wonderful to own, and today's starting point is the most attractive in nearly twenty years.
We own yield where investors are paid for it, hold companies with real current earnings, and favor alternatives with stringent underwriting, inflation protection, and defined outcomes. We are watching the pace of moves on the long end, the durability of corporate earnings, and whether the Fed's language turns into action. This is not an environment to predict. It is one to be positioned for. Stay invested, own quality investments, and build a portfolio with true diversification that doesn’t rely on a single outcome.
David Wrigley
Chief Investment Officer
Source: AAA, as of September 10, 2026
Source: CME Group, as of September 10, 2026
The information contained herein is the opinion of the author as of the date the market update was written and is subject to change without notice as markets change, and new information is available. While Diversify utilizes sources deemed to be reliable, we have not independently verified the content. Investors should carefully consider any changes based on this market commentary and discuss their individual circumstances with their trusted advisors. Past performance is not indicative of future results. This communication is for informational purposes only and should not be construed as investment advice or a recommendation.
