Echoes of History: Lessons from the 1920s—Can High Interest Rates Change the Outcome of the AI Bubble This Time?

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U.S. Treasury yields have climbed to multi-year highs while the stock market is approaching historical peaks at the same time. This seemingly contradictory combination is causing some investors concern. Bloomberg columnist Jonathan Levin points out that high bond yields are not a market alarm, but are a necessary counterbalancing force in the AI cycle to prevent bubbles from spiraling out of control.

Comparing the current situation to previous periods of technological revolution in history, the logic of high yields actually becomes clearer. The experiences of the 1920s and late 1990s show that an overly low interest rate environment can easily turn tech-driven booms into dangerous bubbles. With long-term rates currently elevated, during the AI capital expenditure expansion period they are serving as a “shock absorber” to prevent market overheating.

Recently, the yield on the U.S. 30-year Treasury briefly rose to 5.18%, the highest since 2007; the 10-year yield climbed to 4.66%, the highest since January 2025. Despite the rise in rates, the S&P 500 is still approaching its all-time high, only about 2% below the peak.

Behind this is the support from earnings: Wall Street has revised up the consensus forecast for the index’s earnings per share in 2026 by 7%. Investors’ actions demonstrate that, given the continued improvement in earnings prospects, current rate levels are not viewed as a market catastrophe.

Earnings absorb rates, wealth fuels growth

Earnings growth is continuously absorbing the pressure brought by high interest rates.

Since the start of 2023, the annualized growth of the S&P 500 is about 23%, nearly matching the astonishing 27% posted during the dot-com bubble period. As of this Tuesday, the S&P 500's forward price-earnings ratio is 20.7, higher than the ten-year average of 19, but overall is in the expensive rather than wild range.

The core driver behind this rally is earnings, not liquidity. Since February this year, Wall Street has raised its consensus forecast for the S&P 500's 2026 earnings per share by about 7%. Meanwhile, company leverage levels are not high, and balance sheets are relatively healthy, showing a much greater ability to withstand rising rates than in the past.

At the same time, the stock market's rise has led to a strong wealth effect. Federal Reserve data shows that since the end of 2022, American household net assets have increased by more than $40 trillion. Increased wealth drives consumption, and growth in consumption further supports corporate earnings and stock market performance, creating a continuously reinforcing positive cycle.

Short-term oil, long-term AI: Dual drivers of rising rates

There are two parallel logical lines in this round of rising bond yields. In the short term, tensions between the U.S. and Iran are driving oil prices sharply higher and warming inflation expectations, leading to direct selling pressure in the Treasury market. In the medium and long term, the AI-induced capital expenditure super cycle is structurally reshaping the interest rate environment.

In theory, technological revolutions are often accompanied by higher interest rates. When expectations for improved productivity raise the marginal returns on capital, credit demand expands, and if borrowing costs do not rise in tandem, overheating risks may emerge. Driven by AI, chipmakers are seeing profits surge and data centers are rapidly emerging—a real-world expression of this logic.

However, whether AI can truly realize large-scale commercial monetization remains unknown. If AI companies ultimately convert technological advantages efficiently into profits, the current stock market rally may have more solid support; conversely, if commercialization stalls, the risk of a valuation bubble will resurface. Until then, elevated bond yields are playing the role of market disciplinarian.

Historical lessons: The bubble trap of low-rate eras

History provides an important reference for the present: loose monetary policy tends to foster asset bubbles amid technological revolutions.

In the 1920s, the boom in electrification and automobiles made Radio Corporation of America (RCA) the era's iconic stock, and the economy was thriving. However, the Federal Reserve cut the discount rate in 1927, injecting more fuel into an already overheated market, ultimately resulting in the 1929 market crash and the Great Depression.

The internet frenzy of the 1990s provides a more complex case. Then Fed Chair Alan Greenspan largely maintained a restrained monetary policy, with the real yield on 10-year Treasuries averaging about 3% throughout the 1990s—far higher than this decade’s average of about 1%. This restraint may be one reason the post-dot-com bubble burst did not cause deeper economic trauma.

However, after Russia’s default and the collapse of Long-Term Capital Management (LTCM) in 1998, the Fed urgently cut rates by 75 basis points. In hindsight, this move further fueled the last wave of the bubble’s expansion—though Greenspan resumed rate hikes in June 1999, by then the bubble was basically formed.

The current AI boom is similar: amid the excitement of a technological revolution, a misstep in monetary policy can easily push prosperity into danger. Today’s elevated long-term rates are, to an extent, deliberate restraint learned from history.

The Fed’s policy challenge

Current monetary policy is an extension of the lessons above. Despite Trump’s public calls for deep rate cuts, the Fed has so far maintained a restrictive stance to avoid inflation spiraling out of control again.

For Waller, who is about to take over the Fed, abandoning this stance would not be without cost. Analysts believe the current interest rate level actually serves as a “speed bump”—preventing stock market excitement from turning into uncontrollable speculation.

It’s worth noting that this round of rising yields is not unique to the U.S. Developed markets such as the U.K., Germany, and Japan are also facing rising bond yields, but they are not able to benefit from the AI investment boom as the U.S. does. Thus, the impact of high rates on these economies is more pronounced, reflecting a deepening divergence in the global economy in the AI era.

In the U.S., bond market restraint is keeping the AI boom on a sustainable path. This time, whether high rates can avoid repeating history remains to be seen.

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