Investors use bonds in their portfolios to generate income and provide stability. In return, they accept that bond prices can fluctuate as interest rates change. When market interest rates rise, the value of existing bonds with lower yields generally falls. When rates decline, those existing bonds become more attractive and their prices generally rise.
Rising bond yields have pushed bond returns into negative territory this year. The 10-year Treasury note now yields 5.3%, up from 4.1% at this time last year. Persistently high inflation is one reason. Another is the federal budget deficit.
In the last fiscal year, the U.S. government spent about $7.0 trillion while collecting about $5.2 trillion in revenue, leaving a deficit of roughly $1.8 trillion. Years of deficits have contributed to a national debt of about $40 trillion. As the Treasury issues more debt to finance these deficits, investors may demand higher yields to absorb the additional supply.
A relatively strong economy is also contributing to higher interest rates. One source of that strength has been significant spending on data centers and power generation to support demand for artificial intelligence. Faster economic growth often increases demand for borrowing, which can put upward pressure on interest rates.
The Federal Reserve can influence economic activity by changing the federal funds rate, the rate banks use for overnight lending to one another. The Fed recently raised that rate slightly in an effort to slow the economy and move inflation closer to its 2% target from roughly 3% today.
Looking ahead to 2027, interest rates could decline from current levels. According to the Bureau of Labor Statistics, inflation was 2.4% during the first two months of 2026, but higher oil prices related to the war in Iran pushed inflation into the low-3% range. Excluding energy, inflation was 2.5% in August.
If the war in Iran gets resolved and oil prices ease, inflation could move lower, which would reduce some of the pressure on interest rates. Lower rates would generally be positive for bond prices. A slowing economy, or a recession, could also lead to lower rates.
The federal budget deficit remains an important longer-term concern, particularly for longer-term bonds, because persistent government borrowing can place upward pressure on long-term interest rates.