Forget AI, debt has become the main character on Wall Street as markets just now decided that it’s gotten out of control after years of warnings

Wall Street has become preoccupied with debt, overshadowing the once-celebrated AI boom. For years, U.S. debt has been on an alarming upward trajectory, prompting dire warnings that were largely ignored due to low borrowing costs driving stock market gains. As interest costs consumed a larger share of the federal budget and deficits expanded, rating agencies downgraded U.S. credit, and foreign central banks reduced their Treasury purchases.

The tipping point was unclear, but their global bond selloff recently sent yields to the highest level in two decades, signaling that debt had become a major concern. Joseph Brusuelas, RSM Chief Economist, stated that debt has reached a level where it may become unsustainable. The issue is not limited to the U.S., as other top economies such as the U.K., France, Germany, and Japan also experienced rising yields.

Since the COVID-19 pandemic, governments have continued to spend as if borrowing costs remained low, allowing deficits to worsen despite a more robust economy. Interest rates have surged due to high inflation, while the AI boom has increased annual capital expenditures for an economy that is less sensitive to higher rates. Hyperscalers, too, are increasingly relying on debt for their capital investments, competing with the Treasury Department for bond market dollars.

The high debt levels in many countries have led many to question when market patience would finally run out. Proximity to the U.S.-Iran conflict and fears of persistent inflation have also contributed to the recent yield surge. Federal Reserve Chairman Kevin Warsh's reluctance to provide forward guidance on inflation response has added to the market uncertainty.

Additionally, economic populism, both left-leaning spending measures and right-leaning tax cuts, have fueled expectations of higher inflation and resistance to central bank efforts to rein it in. Capital Economics believes that bond investors now demand greater compensation for fiscal, geopolitical, and policy uncertainties, leading to an elevated term premium and potential for more bond market volatility.