US Economy Runs Hot as GDP Growth Must Outpace Rising Borrowing Costs
The US economy is expanding faster than its debt costs for now, but economists warn that a 5% 10-year Treasury yield could trigger a debt spiral as AI investment and federal deficits drive growth.
The US economy has been running hotter than many expected, absorbing shocks from tariffs and overseas conflict while still expanding at a pace that keeps it ahead of the cost of servicing its $40 trillion national debt. But that lead is narrowing, and economists are warning that the margin between economic growth and borrowing costs is the single most important number in American finance right now.
Federal Reserve policymakers acknowledged the economy's strength this month by raising interest rates to rein in inflation. The move underscored a paradox: the same resilience that has kept unemployment low and corporate profits strong is also pushing Treasury yields higher, making it more expensive for the government to carry its debt load.
For the moment, the math still works. Inflation-adjusted growth has hovered around 2%, but nominal growth—which includes inflation—has been well above 6%. That is still comfortably ahead of the 5.16% yield on the 10-year Treasury note, even after that yield jumped more than a full percentage point since the war with Iran began. A recent gauge of US business activity for September hit a five-year high, suggesting third-quarter growth could accelerate further.
A large share of that momentum comes from the artificial intelligence boom. Capital expenditures from Alphabet, Amazon, Microsoft, Meta, Oracle, and SpaceX are projected to total $870 billion this year, up from $470 billion in 2025. S&P Global estimated last month that spending from a handful of hyperscalers will exceed $1.3 trillion in 2027. Economist Stijn van Nieuwerburgh has said the AI build-out is on track to top the railroad mania as the biggest boom in US history.
The spending is spreading beyond tech. Industrial stalwarts like Caterpillar and GE have been among the biggest beneficiaries of the data center frenzy. «The breadth and magnitude of the AI investment impulse spilling over to other sectors is as surprising as it is extensive,» UBS economist Jonathan Pingle wrote in a note. «The demand impulse from AI appears to be spilling over to help create demand for capex outside of tech.»
The federal government's $2 trillion annual budget deficit adds another layer of stimulus. Much of the money Washington raises by selling debt flows into consumers' pockets, primarily through entitlement payments, which eventually boost profits and stock valuations, according to Research Affiliates.
But the durability of this arrangement is uncertain. Some Wall Street analysts have warned that the AI bubble is poised to pop, which would hobble the economy's hottest engine. Instances of AI agents going rogue and fears the technology could wipe out humanity have led to calls for slowing development—and perhaps less investment. Higher borrowing costs could also cool AI spending.
Rockefeller International Chairman Ruchir Sharma predicted the bubble could burst when the 10-year yield decisively exceeds 5%, signaling a «new era of tighter money, in which AI mega projects will be harder to fund.» Yields topping 5% would also start to approach nominal GDP growth, making the national debt even more unsustainable, he pointed out.
That is precisely what the Committee for a Responsible Federal Budget fears. The budget watchdog has been sounding the alarm for years about the trajectory of US debt and sees GDP growth eventually falling behind the cost of borrowing. «With interest rates on new Treasury bonds and notes at around 5% and medium-term nominal economic growth expected to be closer to 4%, the US is entering a debt spiral,» CRFB said. «This could lead to a fiscal crisis, which could result in exploding unemployment rates, crashing asset values, surging inflation, falling incomes, sharp and unexpected increases in taxes and cuts in government support, or some combination.»
Slower economic growth would not necessarily bring down bond yields, which have been rising for multiple reasons. Other heavily indebted countries and AI hyperscalers are competing for bond investors' capital, so auctions require attractive yields to draw sufficient demand. The geopolitical environment adds another premium. Recent wars, trade friction, and disasters have produced such frequent shocks that they are no longer seen as one-off events but as a sign of a less stable world. That risk gets priced into yields too.
The Fed's willingness to keep a lid on inflation is a wild card. Chairman Kevin Warsh earned some credibility with his hawkish stance, but the market could quickly turn on him and reverse the favorable GDP-debt math the US currently enjoys. «In the past, especially during the 1980s, the Bond Vigilantes pushed the bond yield above nominal GDP to slow the economy,» Wall Street veteran Ed Yardeni wrote in a note. «They haven't done that so far. The risk is that they will do that if the Fed fails to subdue inflation.»
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