The U.S. economy is expanding strongly enough to withstand higher interest rates, but that strength is creating a new challenge for Washington as rising Treasury yields increase the cost of carrying the federal debt.
Nominal economic growth remains above long-term borrowing costs, according to figures cited by Fortune, giving the government some protection as U.S. debt growth continues. Yet the margin has narrowed as the benchmark 10-year Treasury yield climbed above 5%, leaving investors focused on whether economic expansion can continue outrunning the government’s financing costs.
Treasury Yields Test the Economy’s Growth Advantage
Real economic growth has recently been running at around 2%, while nominal growth, which includes inflation, has exceeded 6%, according to the Fortune report. The 10-year Treasury yield, meanwhile, reached 5.16% after rising by more than a percentage point following the outbreak of the Iran war.
Recent business surveys suggest economic momentum remains strong. S&P Global’s flash U.S. Composite PMI Output Index rose to 58.4 in September, its highest reading since July 2021, according to Reuters. Strong new orders helped drive the increase, while businesses also reported mounting price pressures.
The Federal Reserve responded to persistent inflation and resilient domestic demand on September 16 by raising its target federal funds rate by 25 basis points to a range of 3.75% to 4.00%. Policymakers described economic activity as expanding at a solid pace while noting that inflation remained elevated.
That combination creates a difficult balance. Stronger growth increases tax receipts, corporate earnings and nominal GDP, but persistent demand and inflation can also keep interest rates higher. Those rates eventually feed through to federal finances as existing Treasury securities mature and the government refinances debt at newer borrowing costs.
AI Spending Is Adding Fuel to U.S. Investment
Artificial intelligence investment has become an important contributor to the current expansion. Fortune reported that capital expenditure by Alphabet, Amazon, Microsoft, Meta, Oracle and SpaceX is projected to reach $870bn this year, compared with $470bn in 2025.
The effects extend beyond technology companies. Data centre construction requires power equipment, cooling systems, heavy machinery, construction capacity and other physical infrastructure, directing spending toward established industrial businesses as well as semiconductor and cloud computing companies.
That investment also complicates the inflation outlook. Chicago Federal Reserve President Austan Goolsbee said in September that strong demand, including investment associated with AI, may be adding to inflationary pressure.
The longer-term fiscal picture provides another reason to watch interest rates. The Congressional Budget Office projected in February that debt held by the public would rise from 101% of GDP in 2026 to 120% by 2036 under its baseline assumptions. It expects the federal deficit to total $1.9 trillion this fiscal year and reach $3.1 trillion in 2036.
More recent CBO analysis illustrates how sensitive that trajectory is to borrowing costs. In a September scenario where interest rates eventually run one percentage point above the agency’s extended baseline, debt held by the public reaches 222% of GDP in 2056, compared with 175% under the baseline.
The Critical Question Is How Long Growth Can Stay Ahead
The immediate issue is not simply whether Treasury yields cross a particular level. What matters is the relationship among economic growth, interest costs, government deficits and the stock of debt that must continually be refinanced.
The CBO estimates that the average interest rate on federal debt is about 3.4% in 2026, below the yield currently demanded on newly issued 10-year Treasuries because much of the government’s outstanding debt was issued previously at different rates. That average rate is projected to increase as securities mature and are replaced.
Investors will therefore be watching whether AI capital spending remains strong, whether inflation cools and whether the Federal Reserve needs further tightening. If nominal growth stays robust, the economy retains more capacity to absorb higher financing costs. If growth weakens while Treasury yields remain elevated, however, the fiscal arithmetic becomes considerably harder, particularly as persistent deficits require Washington to issue still more debt.
