Capital competition

Accelerating AI buildout, heavy government borrowing to keep rates elevated

The Federal Reserve raised rates for the first time in three years, easing near-term credibility concerns as the U.S. 10-year Treasury yield crossed 5%. But the hike is unlikely to end this year’s sharp rate reset. Intensifying competition for capital remains a key driver, as heavy government borrowing collides with growing AI financing needs. Sticky inflation adds pressure, keeping borrowing costs elevated. What drives yields matters. We stay risk-on and favor select credit for income.

The numbers show the most intense competition for capital since the great financial crisis and the Covid-19 shock. We estimate annual U.S. financing demand could exceed $7.5 trillion by 2030, driven mainly by the capital needs of the AI buildout (see the chart below).

The broader AI and data-center bond universe accounts for about 14% of U.S. investment-grade issuance this year, up from 5% in 2025 and 1% over the previous decade. We think this financing wave has room to run. Markets have been rattled by talk of slowing frontier-model development, but we would not equate that with a slower physical AI buildout. For now, demand remains robust: Most AI compute is used for inference – running existing models – rather than training new ones. With adoption still in its early stages, inference should keep driving demand for compute even if frontier-model progress slows.

That persistent demand for capital is one reason we think borrowing costs can stay elevated. But other forces could push them higher still. The Strait of Hormuz remains effectively closed amid the ongoing Middle East conflict. Brent crude has moved back above $100 a barrel, adding to already sticky inflation pressures driven by a world shaped by supply. Higher energy prices do not just lift headline inflation. If the effects spill over to wages and other costs, they can make core inflation more persistent, potentially keeping monetary policy tighter for longer.

Focus on underlying drivers

That makes what drives yields critical. Central banks shouldn’t interfere with growth-driven competition for capital and can’t resolve energy shortages, but they can prevent an unnecessary rise in term premium – the extra compensation investors demand to hold long-term bonds – by maintaining credibility. The Fed’s rate hike last week helped reestablish that credibility.

So far, higher yields have mostly reflected rising real rates and expectations for tighter policy rather than a sharp increase in term premium. Attempts to suppress yields by tolerating more inflation or without addressing underlying fiscal concerns could undermine that confidence and push term premium higher. But after last week, the risk of a credibility-driven surge looks contained. That matters for our investment views: A rise in yields driven by resilient growth, investment demand, and central-bank efforts to maintain credibility can coexist with our pro-risk stance. A rise increasingly driven by inflation or concerns about policy credibility would be more concerning.

Who ultimately bears the higher cost of capital will vary. Companies with strong earnings and balance sheets have more room to absorb it, while leveraged borrowers face greater pressure. We stay overweight U.S. equities and AI, where resilient earnings can help absorb higher financing costs.

This environment has also created rich opportunities across fixed income, but selectivity is key. We favor short- to medium-term government bonds on a strategic horizon of five years or longer. In credit, higher yields have improved the income on offer, but who investors lend to matters. We prefer attractive coupons away from the two extremes: the weakest borrowers and companies issuing large amounts of debt.

Our bottom line

Heavy government borrowing and the AI buildout are intensifying competition for capital. We stay pro-risk and overweight U.S. equities while favoring attractive coupons away from the weakest borrowers and largest debt issuers.

Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.

Wei Li, Managing Director and Global Chief Investment Strategist at BlackRock Investment Institute, Vivek Paul, Global Head of Portfolio Research – BlackRock Investment Institute, Ehsan Khoman, Economist – BlackRock Investment Institute, contributed to this article.

Disclaimer

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