Rising bond yields, increased tariffs, and soaring energy prices have failed to cool the U.S. economy. Last week, the yield on 10-year U.S. Treasury bonds (which affects mortgage rates and other borrowing costs) climbed to its highest level since 2007, as markets began pricing in another Federal Reserve rate hike. Analysts and economists point to multiple factors driving inflation: oil prices are affected by geopolitical conflicts, strong demand for bonds issued by artificial intelligence companies, and the US national debt has surpassed $40 trillion. Meanwhile, a debate is raging in the market: to what extent is the rise in yields due to a strengthening US economy? And how high can the economy sustain these yields? Ed Yadney, chief investment strategist at Yadney Research, stated, "The core reason for the sharp rise in bond yields is that the US economy is booming." This week, a report from the S&P Purchasing Managers' Index (PMI), which is not usually closely watched, showed that the US economic momentum is still strengthening. The report measures manufacturing activity, while the services PMI climbed to its highest level since 2021, driven by new orders. The labor market also showed resilience. August CPI data showed a 3.4% year-on-year price increase, in line with market inflation expectations, and also increased the probability of a Fed rate hike, while the unemployment rate remained unchanged at 4.1%. Before this spring, the healthcare and social welfare sectors largely carried the workforce; since then, job growth has spread to more industries, with average monthly job gains stabilizing at 74,000 throughout the summer. Top Federal Reserve policymakers believe that strong consumer spending is the main driver of the economy. Federal Reserve Chairman Kevin Warsh mentioned at a recent press conference that economic activity is the core driver of rising long-term yields. Cleveland Fed President Beth Hammark stated at a symposium on Friday that multiple factors have contributed to the rise in yields, with a strong economy being a key one. "The economic data has been quite strong," she said at the Cleveland symposium. "Look at the earnings of listed companies; the market is starting to price in continued better-than-expected corporate performance, and the resilience shown by the economy has already been priced in." She also acknowledged that the market has already priced in more rate hikes and that the US fiscal path is unsustainable. Philadelphia Fed President Anna Paulson also stated this week that despite tariffs and rising oil prices, the US economy continues to show resilience, and even shows increased momentum. She pointed to strong consumer spending, investment driven by the expansion of the artificial intelligence industry, and a stable labor market. After a weak start to the year, U.S. real consumer spending grew at an annualized rate of 3.4% in the second quarter. The Atlanta Fed's GDPNow model currently projects that consumer spending will grow at an annualized rate of over 4% in the third quarter. Paulson believes that the stock market rally may further boost consumer spending. Hammark stated that the U.S. economy remains resilient, and the job market is close to her projected full employment level. "For so many years, we've thought consumer spending would cool down, but that hasn't happened," she said. "Continued consumer spending is the driving force behind economic growth." However, not everyone believes that economic growth is the main reason for higher yields. Will Stith, senior bond portfolio manager at Wilmington Trust, believes that while economic growth is indeed part of the reason for rising yields, the "core factor" is high government spending and fiscal deficits. "The U.S. and its allies are in a near-wartime state... fiscal spending continues to rise, but no one is discussing: should we correct this situation? How long will this situation last?" Stith said in an interview. "This is the main trigger for higher long-term yields." However, Stith also admitted that if the economy contracts, bond yields will be at a lower level. Where will yields go next? Currently, the 10-year US Treasury yield is around 5.2%, and Stith believes it could peak at 5.5%. Once yields break through this level, the Federal Reserve will likely raise interest rates further, putting greater pressure on the economy and causing a stock market sell-off, while a rising stock market is itself a major driver of consumer spending. Yadney points out that the current 10-year US Treasury yield is still below nominal GDP growth, which was 6.6% in the second quarter and is likely to be even higher in the third quarter. Historically, especially in the 1980s, the so-called "bond militia" pushed US Treasury yields above nominal GDP growth to curb overheating. "So far, they haven't done that," he says. "The risk is that if the Fed can't control inflation, this could happen." Yadney predicts that the 10-year US Treasury yield will eventually fall back to the 4.00%-5.00% range this year, returning to the range of the five years before the 2008 financial crisis. “But for now, the risk of rising yields is clearly greater.” One possibility for yields to fall is a resolution to the Middle East conflict and a drop in oil prices; Yadney also suggested another possibility: US Treasury Secretary Scott Bessant could lower bond yields by repurchasing more Treasury bonds and issuing more short-term Treasury bills. The Fed's Next Move Due to high economic growth, coupled with persistent inflation stemming from geopolitical conflicts in Iran, Russia, and Ukraine, the Fed has abandoned its previous plan to cut interest rates. After raising rates by 25 basis points again after three years, Wall Street has begun preparing for further rate hikes. The market currently prices a 66% probability of another rate hike in October and a 52% probability of another in December. Hammark leans towards the Fed needing to raise rates further. “In the current environment, I don't think our policy stance can constrain domestic investment,” she said. She mentioned that in discussions with businesses, she found that, apart from the real estate sector, interest rates are not a constraint on new investment for most companies. “From a growth perspective, it’s good that businesses are continuing to increase domestic investment. But if this brings more inflationary pressure, we must remain vigilant and make sure to bring inflation back under control,” said Stith. He believes that if economic growth and employment data remain strong, and inflation exceeds expectations, the Federal Reserve will raise interest rates in October and December. He thinks that a single 25 basis point increase is not enough to suppress inflation, and another 25 basis point increase may not be enough either, meaning the Fed may need to raise rates by a total of 100 basis points. However, if borrowing costs continue to rise, it may not put the brakes on the economy as it has in the past. Pershing Square CEO Bill Ackman posted on social media, questioning: “What will happen if high interest rates fail to curb demand and investment? The demand for AI computing power and energy is not sensitive to interest rates—the competition for superintelligence brings almost unlimited returns on investment, and the demand for computing power will remain at an immeasurably high level.” “Could it be that old economic models are no longer applicable to the current environment, and the Fed’s judgment has been flawed?” he continued. Based on this logic, he believes that the Fed’s interest rate hike itself may be a wrong decision.