By Gertrude Chavez-Dreyfuss
NEW YORK, Sept 3 (Reuters) - A recent rise in Treasury yields in part reflects growing investor bets that an obscure, theoretical rate consistent with stable growth and inflation is moving higher.
Some believe the so-called R-star, which is a rate that neither stimulates nor restrains economic activity, might be higher than the latest data indicates. Analysts estimate it has risen as the U.S. economy absorbs a strong mix of capital spending tied to artificial intelligence
and heavy government borrowing. The R-star moving higher suggests that interest rates may settle at structurally elevated levels, adding to pressure on bond prices. Still, analysts could not give an exact estimate of the level as the measure can be calculated using different methods and relies on trailing data.
"The likely culprits for higher R-star could be the heavy investment around the AI build-out and higher government debt levels, both of which can boost demand for capital and lift real yields," said Chip Hughey, managing director of fixed income at Truist Wealth in Richmond, Virginia.
The debate matters because if R-star is indeed higher, it could point to higher-for-longer interest rates, with implications for everything from mortgage costs to government borrowing expenses. It would also complicate the Federal Reserve's path to cutting rates, even as markets push bond prices lower.
ESTIMATING THE ELUSIVE NEUTRAL RATE
Long the domain of economists seeking to gauge to what extent Fed policy is restrictive or accommodative, R-star is an esoteric measure notoriously difficult to estimate, analysts said, because it can vary depending on the model and time horizon.
The New York Fed recently released updated estimates of its widely followed Laubach-Williams model through the second quarter of 2026, showing R-star at 1.65%, slightly down from 1.73% in the first quarter. But it has trended higher since the first quarter of 2025 when it was 1.36%.
The current R-star, or neutral rate, with the ongoing ramp-up in bond sales by hyperscalers — the largest cloud computing companies such as Amazon.com, Microsoft and Alphabet's Google — and mounting U.S. borrowing is likely higher than that, market participants said, although they could not provide an estimate. Truist's Hughey said that any R-star estimate involves "equal parts art and science."
"A higher R-star is pushing rates across the curve higher," said Zachary Griffiths, head of investment grade and macro strategy at CreditSights in Charlotte, North Carolina.
YIELD CURVE FEELS UPWARD PRESSURE
A structural increase in R-star is putting upward pressure on two- and five-year yields because it implies the Fed will ultimately need to settle at a higher policy rate.
The 10-year yield is also rising both because investors expect policy rates to increase and because they demand a larger term premium, the extra compensation required to hold longer-term debt. Bond yields were again under pressure this week.
For the 30-year yield, Griffiths believes rising R-star has a "historically asymmetric impact," meaning the rate is biting hardest on this part of the curve because of elevated debt levels and large, persistent deficits.
AI INVESTMENT DRIVES CAPITAL DEMAND
Those fiscal concerns are being compounded by a growing supply of long-term debt beyond Treasuries, particularly from AI-driven borrowing by hyperscalers, as massive bond sales compete with longer-dated U.S. Treasuries for investor capital. That has lifted long-term yields and likely elevated the neutral rate, analysts said.
Ulrike Hoffmann-Burchardi, chief investment officer Americas and global head of equities at the UBS Chief Investment Office, however, said that the Fed "cannot easily cut interest rates back to zero when the structural demand for capital remains this high."
Still, some analysts think the tech-driven increase in R-star could be temporary if AI in the long term proves disinflationary.
"In the near term, the impact of AI is going to be a higher R-star before potentially flipping to a lower nominal policy rate in the longer term depending on the disinflationary or even potentially deflationary effects of it," said CreditSights' Griffiths.
But as the AI boom is unfolding, the U.S. government continues to borrow heavily, with the national debt hitting $40 trillion. The result is an unusual combination that shows huge public sector demand for capital occurring alongside a surge in private sector investment. This scenario is likely to keep the neutral rate higher even if the Fed is on an extended pause.
Yet analysts noted that it is far too early to say whether those forces represent a long-lasting change in the economy or a temporary phenomenon.
Economists will need years of data to determine whether the latest investment surge, for instance, represents a structural shift or another cycle that eventually fades, analysts said.
"The Fed is currently trying to assess whether or not we are sufficiently restrictive against a backdrop in which there is a tremendous amount of investment being made in the economy and where there's also big demand for capital coming from the government," said Truist's Hughey.
(Reporting by Gertrude Chavez-Dreyfuss in New York; Editing by Megan Davies and Matthew Lewis)
