High gas prices and low consumer sentiment over the cost of living have obscured how robust the U.S. economy has been lately.
Not only has the economy absorbed shocks from President Donald Trump’s tariffs and war on Iran, it has been running hot.
Federal Reserve policymakers recognized that the economy isn’t just resilient but thriving as they hiked interest rates earlier this month to rein in inflation.
At the same time, the prospect of a hot economy that adds more inflationary pressure has sent Treasury yields soaring, creating a heavier burden for servicing $40 trillion in U.S. debt.
That means the economy is stuck on a hamster wheel, scurrying to outrun borrowing costs and avoid a reduction in speed that allows debt to grow faster than the economy.
For now, GDP is staying ahead of interest rates. While growth adjusted for inflation has been around 2%, nominal growth has been well above 6%—still more than the 5.16% 10-year yield, even after it jumped more than a full percentage point since the Iran war began.
Growth in the third quarter could show even more acceleration, as a recent gauge of U.S. business activity for September hit a five-year high.
Of course, the AI boom has a lot to do with that. 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 the handful of hyperscalers will exceed $1.3 trillion in 2027.
In fact, the AI build-out is on track to top the railroad mania as the biggest boom in U.S. history, according to economist Stijn van Nieuwerburgh.
The infusion of all that capital is also spreading beyond the tech sector to the so-called old economy. Indeed, 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 on Wednesday. “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 also represents more stimulus. Much of the money the government raises by selling debt goes into consumers’ pockets, primarily via entitlement payments, which eventually boost profits and stock valuations, Research Affiliates said in a note early this year.
But how much longer can the U.S. economy keep growing faster than U.S. debt?
Some Wall Street analyst have been warning that the AI bubble is poised to pop soon, hobbling the economy’s hottest engine.
Instances of AI agents going rogue and fears the technology could even 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 pop 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.”
In addition, yields topping 5% would start to approach nominal GDP growth, making the national debt even more unsustainable, he pointed out in a recent Financial Times op-ed.
That’s precisely what the Committee for a Responsible Federal Budget is worried about. The budget watchdog has been sounding the alarm for years about the trajectory of U.S. 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 U.S. is entering a debt spiral,” CRFB said Wednesday. “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.”
After all, slower economic growth won’t necessarily bring down bond yields, which have been rising for a number of reasons.
Other heavily indebted countries and AI hyperscalers are competing for bond investors’ capital, so auctions require attractive yields to draw sufficient demand.
Then there’s the geopolitical environment. The recent wars, trade friction, and disasters have produced such frequent shocks that they are no longer seen as one-off events but a sign of a less stable world. That risk gets priced into yields too.
The willingness of the Fed 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 U.S. 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 on Wednesday. “They haven’t done that so far. The risk is that they will do that if the Fed fails to subdue inflation.”
This story was originally featured on Fortune.com
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