Monetary Policy — Alpha.Sources

Crowding out and AI debt issuance

Analysts and economist are, broadly speaking, offering up four separate reasons for the continued rise in developed market, and in particular, US bond yields. A resurgence in inflation due to the negative supply shock in global energy markets as a result of the US-Iran war, loose fiscal policy with little or no credible plan for any near-term consolidation, a reflection of improving underlying growth and rising productivity—linked to the AI investment boom—lifting the real neutral rate for “the right” reasons, and more specifically in the context of AI, rapidly accelerating AI debt issuance “crowding out” government debt issuance, lifting the cost of capital for the sovereign.

The idea that AI debt issuance is now a key driver of rising bond yields via a “crowding out” effect has captured a lot of attention in recent weeks with key Wall Street analysts and publications offering evidence to support the claim. The FT’s Toby Nangle, however, is not so sure, and in a recent FT Alphaville piece he sets out to rebut the claim.

Fiscal dominance is here, or is it?

One of the more useful AI tools that I have set up recently is a bi-weekly macro and demographics theme scout, which collects material on a given topic and runs through a number of recent and older sources, and synthesises this material into a brief essay, as well as a text to speech (TTS) document so that I listen back with the ElevenLabs text-to-speech app.

I thought it might be useful to recycle some of this material on the blog. One of the topics my AI scout landed on earlier this year was fiscal dominance, and whether developed markets are now slipping into this regime after a long period in which monetary dominance—activist monetary and passive fiscal policy—was the norm. I would frame the question like this. Has fiscal largesse during Covid, the subsequent fiscal support to protect against sequential global supply shocks in energy, and more generally deglobalisation and a focus the government balance sheet as a strategic lever for economic security pushed monetary policy into a Sargent and Wallace world of "unpleasant arithmetic”?

Here is the essay with some additions by me and more recent contributions.

Global Leading Indicators, July/August 2026 - On the precipice

Global leading indicators stabilised over the summer, albeit at a weak level, so far dispelling fears that the downturn which began in Q2 marked the start of an accelerated decline in the headline LEI diffusion index into outright negative territory.

The deterioration in global LEIs since March—coinciding with the shock to global energy markets from the US-Iran war—has unfolded against an increasingly stark divergence across financial markets. Equities remain relatively calm, with the rotational tape continuing, while bond markets are closer to panic as a combination of inflation concerns—shifting the outlook for monetary policy—and fears over persistently large fiscal deficits in developed economies pushes yields higher.

The key question is whether this repricing in global bonds ultimately spills over into equities, tightening financial conditions through lower equity prices and, by extension, delivering a further hit to leading indicators. For now, that transmission is not happening. One explanation is that equity markets view rising yields as a natural counterpart to the AI boom: stronger investment is supporting growth while raising expectations for future productivity gains. Add to this the crowding-out of government bonds by surging private-credit issuance to fund the AI build-out, and the coexistence of rising yields and robust equity markets looks less anomalous, for now.

Global Leading Indicators, June 2026 - Downturn confirmed

Global leading indicators deteriorated further at the end of Q2, with revisions pointing to a broadening weakness that has been building since March. This could still reflect the residual effects of the disruptions following the US-Iran war, but the signal is clear nonetheless. A more hawkish tilt in global monetary policy, as inflation risks have resurfaced, has likely contributed to the weakness, alongside uncertainty over the resilience of global consumer spending as real income growth comes under renewed pressure, and a fragile outlook for investment outside AI.

The silver lining is that the accelerated downturn in the headline LEI diffusion index masks increasing divergence across countries, with several key economies still remaining in expansion territory, as shown in the first chart below. The bad news for investors, however, is that—as I explain below—the probability of negative equity returns over the subsequent six months has increased markedly following the LEI diffusion index's recent move below zero.

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