What’s Actually Driving Bond Yields Higher: Q3 US Economic Outlook

Bond yields have climbed significantly, and clients have noticed. The 10-year Treasury yield stood at about 5.18% in early October 2026, more than double its roughly 2% average during 2017-19.

Rates that high change what a retirement plan costs, what a mortgage costs, and what a portfolio is worth, so the question of why they rose is not academic. The most common answer points to the federal debt, and much of the coverage of the global bond selloff has followed that logic.

Our read is different. What moved yields this year was a change in how investors see the strength of the US economy and the labor market, not a change in how they see the debt. The artificial intelligence boom is a large part of that strength. AI spending is adding demand to an economy already running at roughly full capacity, and that pushes rates up.

However, the boost is unlikely to last. For companies to earn a return on what they are spending on AI, they will eventually have to cut jobs, and that has not happened yet. If jobs are cut, demand falls. If job cuts don’t happen, AI spending itself must contract for lack of return. Either path calls for the Fed to cut rates deeply, which is why we still see the 10-year Treasury at 3.50% by 2029, down from 5.2% today.

Below are core findings from our latest US Economic Outlook report most likely to come up in client conversations. Looking for quarterly details, charts, and year-by-year forecasts? Download the full Q3 US Economic Outlook for the complete picture.

Morningstar's Preston Caldwell expects the economy to run a bit cooler than consensus through 2028.  

In our latest forecasts, GDP growth is pulled forward slightly, owing mainly to expectations about AI spending. We now project 2.3% in real GDP growth in 2026 and 2.1% in real GDP growth in 2027. 

What it means for advisors: Our view sits below consensus where it counts most for clients. We expect unemployment to average 4.6% in 2028 against 4.2% for consensus, and GDP growth of 1.7% that year versus 2.1%. If a client's plan assumes the consensus path, 2028 is the year the difference shows up in hiring, wages, and spending power.

What’s behind the global bond selloff? Much ink has been spilled chalking it up to rising worries about the US government’s fiscal health. But we believe that shifting perceptions of the strength of the US economy and labor market have played a bigger role. 

Almost all this year’s yield increase came from real yields, meaning yields after inflation is stripped out. Inflation expectations embedded in bond yields have barely moved since 2025, with the 30-year breakeven hovering around 2.3% for the past five years.  

Gold more than doubled between the start of 2025 and February 2026, which many read as investors fleeing the dollar ahead of a burst of inflation. But bond market inflation expectations never budged, so that explanation doesn’t hold.  

The timing doesn’t fit either. Debt worries should hit the longest bonds hardest, yet the 2-year yield rose 1.17 percentage points this year against 0.49 for the 30-year. Investors are also demanding more yield to hold long bonds, but only enough to get back to the 1990-2019 average of 1.0%, after a decade when central bank buying held it artificially low. 

The Congressional Budget Office’s current debt projection is in line with its February 2024 edition, and projected 2050 debt/GDP sits about 20 percentage points below the January 2020 forecast.

What it means for advisors: Why yields rose matters for whether clients should hold onto bonds. If bond yields were moving higher because risks were increasing, that might argue for investors being wary about bonds. But an increase in bond yields driven by economic strength is a different matter, as it should lead to improved risk-adjusted returns for bond investors in years ahead.

High-tech real private fixed investment rose 14.1% year over year in the first half of 2026, while nonresidential investment excluding high tech fell 3%. This comes as spending on IT equipment and data center construction has exploded upward to facilitate the training and operation of AI models. Tech-related investment contributed about a percentage point to GDP growth over that period, offset by contraction across all other private fixed investment.

Productivity is doing the rest: labor productivity averaged 1.9% over 2020-25 against 1.0% in the decade before the pandemic. The result is an expansion with almost no job growth. We expect GDP growth of 2.3% in 2026, slowing to 1.7% in 2028 before rebounding to 2.9% in 2030.

Inflation jumps to 3.4% in 2026 on roughly 0.8 percentage points of uplift from the oil shock, then falls to 2.4% in 2027 and averages 2.0% over 2028-30.

What it means for advisors: One theme is carrying an unusual share of growth, and it is the same theme carrying an unusual share of index returns. For advisors, it’s worth checking how much of a client’s equity exposure rests on AI spending continuing at its current pace. Our 2026 Diversification Landscape is a useful companion for that conversation.

Real wage growth turned negative in the second quarter of 2026, at negative 0.4% year over year. The personal saving rate was 2.8%, more than 4 percentage points below the 2018-19 average of 6.9%.

Weak wage growth has pushed domestic corporate profits above 13% of gross domestic income, up from 9% in 2019, a major driver of the earnings growth behind the market’s run. We expect consumption growth to weaken to 1.7% by 2028.

We expect consumption growth to weaken to 1.7% by 2028. Net worth is on track for about 600% of GDP by the end of 2026, up from 520% over 2018-19, and rising portfolios make setting money aside feel less urgent. By our estimate, that feeling accounts for about half the gap between today’s saving rate and the prepandemic norm.

What it means for advisors: Clients may be spending as though their portfolios will keep climbing and saving almost nothing as a result. A flat year for equities would hit their spending plans harder than they expect. Reset expectations while gains are still there to point to.

We expect two rate cuts in the second half of 2027 and four more in 2028, bringing the federal-funds rate to 2.50% to 2.75%. That lands 175 basis points below what the market is pricing, which we believe reflects an overestimate of the natural rate of interest.  

The effects reach past Treasuries. The 30-year mortgage falls from 6.55% in 2026 to 5.25% by 2029, and that shift is what turns residential investment from negative 3.2% growth in 2026 to 10.7% in 2029.

What it means for advisors: If our US economic forecast holds, reinvestment risk shows up well before duration risk does. For the other signals we track, from the yield curve to credit spreads, review our advisor cheat sheet to recession indicators.

Inflation had come most of the way back to the Fed's 2% target before this year, dropping to 2.6% in 2024 from 6.5% in 2022. Then progress stalled, with inflation holding at 2.6% through 2025. These are PCE figures, the measure the Fed prefers, which usually runs a little below the CPI numbers clients see in headlines.

We expect inflation to jump to 3.4% in 2026, driven mainly by about 0.8 percentage points of uplift from the oil price shock. Tariffs are the other factor, pushing up core goods prices by roughly 0.3 percentage points in 2025, and core services inflation, excluding housing, has been stickier than expected.

Both are temporary. We expect inflation to ease to 2.4% in 2027 and average 2.0% over 2028-30. This oil shock is narrower than the supply shocks of 2021-22, should pass more quickly, and is landing on an economy with far less spending power behind it. Workers have little bargaining power, so wage growth is running at a pace consistent with 2% inflation or lower. Housing inflation is trending down as well, from 5.4% in 2024 to a forecasted 3.2% in 2026 and 3.0% in 2027.

What it means for advisors: Clients watching prices rise again may push to add inflation protection. The case for patience is that nothing underneath this is self-sustaining. The supply shock in 2021-22 had wage growth, pent-up demand, and savings behind it. This situation is an oil shock combined with tariffs, with workers losing ground rather than gaining it. Hedges bought at today's prices would be protecting against a repeat our forecast doesn't see coming.